A savvy investor can get a decent return if he enters a derivative whose purchase price is less than the asset price at the end of a futures contract. It goes without saying that this is not always a cake walk, which means that the importance of understanding the underlying asset of the derivative is invaluable. Too, there are two main categories of derivatives: lock-like futures and forwards that are binding, and options, such as swaps, which are partly non-binding. Both can be used for protection, mitigation or rewards through speculations that can bring stability or cause havoc. Derivative contracts are agreements that all parties must respect. You can consult a legal and/or financial expert when reviewing these types of contracts, as it is always important to fully understand the terms of the agreement before signing. It is important to remember that when they protect themselves, companies do not speculate on the price of the commodity. Instead, protection is only one way for each party to manage risk. Each party has incorporated its profit or margin into its price, and the hedging helps protect those benefits from the elimination by market movements in the price of the commodity.
Whether the price of the product is higher or lower than the futures contract price until the expiry of the futures contract, both parties covered the benefits of the transaction by entering into the contract between them. In this example, both the futures buyer and the seller may have a security risk. Company A needed oil in the future and wanted to offset the risk that the price would rise in December with a long position in an oil futures contract. The seller could be an oil company that was worried about falling oil prices and wanted to eliminate that risk by selling or “shorting” a futures contract that would set the price it would receive in December. The most common underlying assets for derivatives are equities, bonds, commodities, currencies, interest rates and market indices. These assets are usually acquired through brokers. In the financial field, an option is a contract that gives the buyer (owner) the right, but not the obligation to buy or sell an underlying or a basic instrument at an exercise price determined at a date or before. The seller has an obligation to execute the transaction – that is, to sell or buy – if the buyer (owner) “exercises” the option. The buyer pays a premium to the seller. An option that gives the owner the right to buy something at a certain price is a “call option”; an option that gives the owner the right to sell something at a certain price is a put option. Both are often negotiated, but for reasons of clarity, the appeal option is more often discussed. The evaluation of options is a theme of ongoing research in the field of scientific and practical finance.
In principle, the value of an option is divided into two parts: suppose, for example, that the farmer concludes a futures contract with a miller in April 2020 to sell 5,000 bushels of wheat in July for $4,404 a bushel. As of the July 2017 expiry date, the price of wheat falls to $4,350, but the miller must purchase at a contract price of $4,404, which is higher than the prevailing market price of $4,350. Instead of paying 21,750 $US (4,350 x 5,000), the Meunier pays 22,020 US dollars (4,404 x 5,000) while the farmer reimburses a higher price than the market.