subject: F&O Derivatives - for amateurs [print this page] Here is a basic introduction to F&O Derivatives for those who are new to the world of stock market trading.
Derivative, as the word suggest has no value of its own. The value is derived in full from the value of the asset in consideration. These underlying assets can be any of the following; commodities, securities, live stock, currency, bullion or anything else. Derivatives also mean future or forward option or any hybrid contract of a prefixed period which is in turn linked to the purpose of the contract for fulfilling the value of a specified financial or physical asset or securities.
The second amendment to the Securities Laws Act of 1999 includes derivatives in the definition of securities. Derivatives include the following;
- A security that is derived from a share, loan, debt instrument, risk instrument, a contract for differences or any other recognized form of security.
- They can also include a contract that derives its actual value from the prices or the index of the prices of the underlying securities that are being considered.
A futures contract is basically an agreement to sell or buy underlying securities on a future date. This contract is legally binding. These contracts are standardized ones as far as factors like delivery time & date, quality (when it is related to contracts), quantity and settlement place. This contract's expiry date is pre-determined. On this date the contracts are settled either by cash payment or by delivering the underlying assets. Cash settlements are employed to settle any obligations that arise out due to the valuation of the underlying asset.
Finally we move on to an Options Contract; the last term in F&O Derivatives;
In an Options Contract the buyer or holder has the right to buy or sell an underlying asset at a prefixed price within the specified period of the contract or at the end of it. This right the buyer has to purchase from the seller for an amount which is known as a premium.' The seller is under obligation to bring about a settlement of the contract as per the terms decided as and when the buyer exercises the aforementioned right. Here, the underlying assets are the same as those in a Futures Contract.
F&O Derivatives - for amateurs
By: Sharad Gaikwad
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