On spot markets, actual underlying assets (such as stocks) are traded. Delivery and payment take place immediately after the trade is concluded. On a futures market, however, contracts for future purchases and sales are traded. Delivery and payment take place at a fixed price and at a future date.
Standardization of contracts is crucial for smooth trading. Underlying assets of products traded on futures markets include, for example, high-volume stocks, indices, commodities, and interest rates. Financial products derived from underlying assets, such as futures and options, are also called derivatives.
Futures
In a futures contract, two parties enter into a binding agreement for the future delivery of the underlying asset at a specific price (settlement price). The position of the party obligated to sell is called a short position, while that of the party obligated to buy is called a long position.
The term “position” describes the rights and obligations a market participant has following a specific transaction (buy/sell). It is often represented as a profit-and-loss chart.
Options
An option is the right to buy or sell a specific quantity of an asset (underlying) at a specified time or within a specified period and at a price agreed upon in advance.
There are two types of options:
- Call
The right to buy the underlying asset - Put
The right to sell the underlying asset
An option entitles the buyer, in exchange for payment of a premium (option premium), to buy or sell a specific quantity of a specific underlying asset at a specified time or within a specified period and at a predetermined price (strike price) (long position). However, the buyer is not obligated to exercise this right. As the holder of the option, the buyer may also allow it to expire.
In contrast, the seller of an option (writer) is obligated to buy or sell the underlying asset (short position) if the buyer exercises the option.
Forward contracts: significance for market participants
- Significance for investors: Derivatives offer investors the opportunity to achieve high returns (but also to suffer a total loss) with a risk that can be calculated in advance. Investors can reduce (hedge) or increase (trade) this risk. Fund managers hedge their portfolios against price losses and interest rate fluctuations by locking in a specific price or interest rate through a put option.
- Significance for companies: Export-oriented companies, for example, can hedge against exchange rate risk by locking in a specific exchange rate through a currency option.
