When you invest in derivatives, you are investing in the underlying value of goods like commodities such as oil but also shares. Examples of derivatives are options, futures, swaps and forwards. With derivatives one can speculate but also reduce the risk of one’s investment portfolio.
With an option you buy the right to purchase an underlying asset such as oil or to sell at a fixed price within a specified time. You will have to pay a premium for the option. You can apply options to speculate on rising or falling underlying values.
A swap is a derivative in which one party exchanges a particular risk or cash flow with those of another party. These two components are called the “legs” of the transaction. The expression comes from the verb “to swap”. Swaps are derivatives and are so-called derived products. When rights of swaps are owned with a specific underlying value, one speaks of synthetic assets. When these swaps are securitized, one speaks of a synthetic transaction.
A futures or a forward contract is a financial contract between two parties who agree to sell a product or financial instrument at a specified time at a predetermined price and certain quantity. These parties agree on a future transaction. In finance a futures contract is a derivative and derives its value from the price of another product. That what relates to the future contract is known as its underlying value.
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