Derivatives

Derivatives in Stock Market consist of Futures and Options

As well as options and futures, from time-to-time you will also hear the term ‘derivatives’ bounded about. As with debentures earlier, derivatives is the more technical legal term by which options and futures are known by and signifies that futures and options are instruments whose price is determined by the price movement of an underlying security or assets. In other words, the value of a derivative derives from an underlying contract – hence its name. But it is, in fact, the collective term for options and futures, so don’t be put off if you hear this term in the future.

Futures:

Futures trading is different from investing in the stock market or bonds since you don’t actually own anything. In futures trading, you are speculating on the future direction of the price in the Stock you are trading. This is different for beginners in futures trading; it is like a bet on the future price direction. The terms “buy” and “sell” merely indicate the direction you expect future prices will take.

Options:

Stock options are not ownership in anything; unlike stocks, the holder of an option doesn’t possess part ownership in a company; this is simply an agreement between two investors that one party agrees to deliver something to another party within a specific time period and for a specific price. This eliminates the ownership part of the agreement as well as the idea that you must possess a particular stock in order to implement a position.

Ask Price

The price at which a seller is offering to sell an option or stock.

Assignment

The receipt of an exercise notice by an option writer (seller) that obligates him to sell (in the case of a call) or purchase (in the case of a put) the underlying security at the specified strike price.

At-the-money

An option is at-the-money if the strike price of the option is equal to the market price of the underlying security.

Automatic Exercise

A protection procedure whereby the Options Clearing Corporation attempts to protect the holder of an expiring in-the-money option by automatically exercising the option on behalf of the holder.

Bearish

An adjective describing an opinion or outlook that expects a decline in price, either by the general market or by an underlying stock, or both.

Bear Spread

An option strategy that makes its maximum profit when the underlying stock declines and has its maximum risk if the stock rises in price. The strategy can be implemented with either puts or calls. In either case, an option with a higher striking price is purchased and one with a lower striking price is sold, both options generally having the same expiration date.

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