What Are the Two Basic Types of Derivative Contracts

Derivative contracts are financial instruments that derive their value from an underlying asset. These assets can range from stocks, bonds, currencies, commodities, and more. Two basic types of derivative contracts that are commonly traded in the financial markets are futures and options.

Futures contracts:

Futures contracts are agreements between two parties where they agree to buy or sell an underlying asset at a specified price and date in the future. The buyer of the futures contract is obligated to buy the asset, while the seller is obligated to sell the asset. Futures contracts are standardized contracts and traded on exchanges. The contracts specify the quality and quantity of the underlying asset, the delivery date, and the price. Futures contracts are often used to hedge against potential losses or to speculate on the future price of an asset.

Options contracts:

Options contracts are agreements between two parties where one party has the right but not the obligation to buy or sell an underlying asset at a specified price and date. The buyer of the options contract pays a premium for the right to buy or sell the asset, while the seller receives the premium but is obligated to sell or buy the asset if the buyer chooses to exercise their option. There are two types of options contracts – call options and put options. Call options give the buyer the right to buy the underlying asset, while put options give the buyer the right to sell the underlying asset. Similar to futures contracts, options contracts are often used to hedge against potential losses or to speculate on the future price of an asset.

In conclusion, futures and options contracts are two basic types of derivative contracts that are widely used in the financial markets. Futures contracts are agreements between two parties to buy or sell an underlying asset at a specified price and date in the future, while options contracts are agreements that give the buyer the right but not the obligation to buy or sell an underlying asset at a specified price and date. Both contracts serve the purpose of risk management and speculation in the financial markets.