What are Derivatives? The SWAPS and the difference between OPTIONS and WARRANTS

OPTIONS

An “OPTION” is a derivative contract which allowing the recipient of them (OPTION Holder) the right, but not the obligation to make a known transaction (BUY or SELL) of a known asset (listed on the Exchanges markets) at a known price “Strike” (It doesn't change over time, no matter what happens to the stock price) in a known pre-defined time frame (Option’s Term or Duration).

  • If the time frame is finalized before the end of the Option’s Contract Duration (Owner’s decision) then is called an “American Option”; but, if the time frame finishes accord the stipulated term of the contract then is called an “European Option”.


You can trade Option’s Contracts on stocks, bonds, currencies, and commodities listed on the Exchanges markets, and they offers the buyer the opportunity to buy or sell an underlying asset (depending on the type of Option’s Contract they hold).

Unlike FUTURES, the holder is not required to buy or sell the asset if they decides not to “choose the option”.


Types of Option’s Contracts

There are two types of “OPTIONS” (BULL and BEAR) which are typically bought and sold through online or retail brokers (one gives you the right to buy the asset and the other gives you the right to sell it).

  • CALL: Is the right to buy an asset at a price.
Is “on the money” when the strike price is above the underlying stock value and will be "out of the money" when the strike price is below the underlying stock value.
 
  • PUT: With these derivative contract you can purchase the right to sell your asset at the strike price anytime until the expiration day.
A put option is “on the money” when the strike price is below the underlying stock value and will be "out of the money" when the strike price is above the underlying stock value.


“OPTIONS” (CALL and PUT) are used like business tools in companies around the world; businesses use them to protect against volatility; investors use them to protect it selves against future loss and traders (speculators) try to make huge profits with little investment.
“OPTIONS” (CALL and PUT) are used like business tools in companies around the world; businesses use them to protect against volatility; investors use them to protect it selves against future loss and traders (speculators) try to make huge profits with little investment.


WARRANT 

Warrants are similar to OPTIONS; the only difference between both are that WARRANT Contract generally are issued by the company itself (not a third party) and they are traded Over The Counter (OTC) more often than in an Exchange Market. 


 

SWAP 

A SWAP Contract is a contract in which parties agree to trade a variable performance cash flows for a fixed market rate on a future date
The most common application of SWAP is hedging against risk. 

 

Types of SWAP Contracts 

There are different types of SWAP Contracts, according the asset chosen: 

 
  • Interest Rates (Plain Vanilla) SWAP:
These kind of SWAPS are, as usual, where one party exchanges a fixed rate for a floating rate (and vice versa) on the pre-agreed intervals in the life of the contract
 
  • Currency SWAP:
This kind of SWAP Contract involves the counterparties exchanging his principal amount or their interest payments in different currencies (hedges their investment position from fluctuations on the currency exchange rate). 
 
  • Commodity SWAP
On these kind of Contracts, the counterparties exchange fixed cash flows (a pre-agreed amount of a product) based on a commodity’s spot price
 
  • Credit Default SWAP (CDS):
It kind of Contracts provides insurance from the default of a financial debt instrument when the purchaser transfers the premium payments to the seller.

A SWAP Contract is a contract in which parties agree to trade a variable performance cash flows for a fixed market rate on a future date.
A SWAP Contract is a contract in which parties agree to trade a variable performance cash flows for a fixed market rate on a future date.


 

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