What is meant by derivative contracts and its major types?

Derivatives are financial instruments whose value is derived from underlying assets. One of the key characteristic of financial market is that it keeps on fluctuating. Prices of currencies, shares, gold, silver and other commodities keeps on changing and business associated with them faces risk because of these price movements. To reduce this risk modern finance provides a method which is known as hedging. Derivative contracts are popularly used to hedge against future price risk. Traders prefer to use derivatives tips, mcx tips and more while trading to ensure their good returns.Derivatives contracts can be standardized which are traded over the exchange and it can also be customized as per traders needs known as over the counter derivatives.

Types of derivative contracts

1. Forward contract

It is an agreement between two parties a buyer and a seller who agrees to buy/sell something at a later date on pre decided price. They are not standardized form of contract as there is no regulatory body here.

2. Future contract

Future contracts are standardized forward contracts as they are traded over the exchange and these contracts are subjected to daily settlement procedure. Here trader who faces loss pay trader who makes profit everyday. In this contract there is no counter party risk.

3. Option contract

It is the most important part of derivative contract. Option contract gives right to buy/sell underlying assets but there is no obligation to do so. To enter in this contract a premium amount has to be paid which an investor loose in-case loss occurs. Option contracts are of two types primarily: Call option, Put option.

4. Swap

Swaps are the most complicated type of derivative contract. It enable the participants to exchange their streams of cash flow. Popular types of swap contacts is : currency swap and interest rate swap. This contract facilitates different companies to avoid foreign exchange risk.They are usually not traded on exchange.

Some important SEBI guidelines for derivative contracts :

1. Derivative trading should take place thorough an on-line screen based trading system.
2. It should have a satisfactory system to look after investors complaints and other irregularities which occur while trading.

Modern derivative contracts offers countless combinations of these basic types of contracts which results in creation of highly complex contracts. Traders can design different contracts according to their needs and successfully hedge against future price risk using derivative contracts. Financial advisors are often hired to get recommendations on trading tips, currency tips and more to improve performance and earn better returns. Along with traders, speculators also exists in futures market. Learn about market and always take decision based on facts. Never follow anyones trading path blindly. First understand the market conditions and then conclude which strategy is going to give you best possible results.

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