Today, investors have a fairly wide range of financial instruments and opportunities at their disposal, both to make money on stocks and securities, and on derivative instruments (derivatives).

The derivatives market is one of the main and most active segments of the modern financial system. However, most novice investors have very little understanding of what derivatives are. Accordingly, the opportunities that open up for investors thanks to such instruments remain unclaimed. Or, on the contrary, investors take a thoughtless risk, having little idea of ​​the risks of this instrument.

The essence of a derivative as a financial instrument

To understand what derivatives are and why they are needed, first of all, you need to understand that they are, in simple words, derivative financial instruments. That is, there is an asset that is considered underlying. According to it, a bilateral agreement is concluded, the participants of which undertake to complete a transaction on pre-established conditions.

Despite the complexity of the wording, such agreements are often found in our everyday life. By the way, the simplest example is purchasing a car at a car dealership under the “made to order” scheme. In this case, the buyer enters into an agreement with the dealership for the supply of a car of a specific model, in a specific configuration and at a specific fixed price.

Such an agreement is a simple derivative, in which the asset is the ordered car. Thanks to the concluded contract, the buyer is protected from changes in value, which may increase by the agreed date of purchase. The seller also receives certain guarantees - a rare car, which he purchases from the manufacturer, will definitely be purchased and will not “hang” in his salon as “dead weight”.

The modern derivatives system began to take shape in the 30s of the 19th century. Financial derivatives are a product of the 20th century. The starting point is considered to be 1972, when the international currency market that we know today finally took shape. If previously only real goods were used in such transactions, then with the advent and development of financial derivatives, it became possible to conclude contracts in relation to currencies, securities and other financial instruments, up to the debt obligations of individual companies and entire states.

The Russian derivatives market was formed in the 90s of the last century. Despite the fact that this segment is actively developing, it is characterized by the problems of all young markets. The main feature is the lack of competent personnel, especially among ordinary market players. Not all participants know for sure what derivatives are and their properties. All this leaves an imprint on the development of the market.

Types of derivatives

Classification helps to fully understand what a derivative is and why it is needed. It can be built according to two main features. First is the type of underlying asset:

1. Real goods: gold, oil, wheat, etc.
2. Securities: shares, bonds, bills and much more.
3. Currency.
4. Indexes.
5. Statistics data, for example, key rates, inflation rates, etc.

The second classifying feature is the type of pending transaction. From this point of view, there are 4 main varieties:

1. Forward.
2. Futures.
3. Optional.
4. Swap.

A forward contract is a transaction in which the participants agree on the delivery of an asset of a certain quality and in a specific quantity within a specified period. The underlying asset in forward contracts is real goods, the rate of which is agreed upon in advance. The above example of a car dealership falls into this category. This example really captures the essence in simple language, without fancy words.

Futures is an agreement under which a transaction must take place at a specific point in time at the market price on the date of execution of the contract. That is, if in a forward contract the cost is fixed, then in the case of a futures contract it can change depending on market conditions. The only obligatory condition of futures contracts is that the commodity will be sold/purchased at a specific point in time.

An option is the right, but not the obligation, to purchase or sell an asset at a fixed price before a specific date. That is, if the holder of shares of a certain enterprise announces his desire to sell them at a certain price, then the person interested in the purchase can enter into an option contact with the seller. According to its condition, the potential buyer transfers a certain amount of money to the seller, and he undertakes to sell the shares to the buyer at a set price.

However, such obligations of the seller remain valid only until the expiration of the period specified in the contract. If by the specified date the buyer has not completed the transaction, then the premium he paid goes to the seller, who receives the right to sell the shares to anyone.

A swap is a double financial transaction in which the underlying asset is simultaneously purchased and sold under different conditions. At its core, a swap is a speculative instrument and the only purpose of such actions is to profit from the difference in the price of contracts.

Why are derivatives needed?

In the modern financial system, derivatives and their properties are used in two ways. On the one hand, this is an excellent tool for hedging, that is, insuring risks that invariably arise when concluding long-term financial obligations. Moreover, they are most often used for speculative earnings.

How forward transactions are used has already been discussed above. This is a classic option for hedging price risk. However, in the modern commodity market, futures transactions have become more widespread.

The use of futures allows the seller to insure against financial losses that may occur if the underlying asset he owns is unclaimed. By concluding a futures contract, the owner of an asset can be firmly confident that he will definitely sell it, thereby receiving real money at his disposal.

For the buyer, the value of a futures contact is that he receives a guarantee for the acquisition of an asset that he needs to implement his plans. For example, a manufacturing enterprise needs a stable supply of raw materials, since stopping the technological cycle threatens serious losses. Therefore, it is profitable for management to buy futures for the supply of a specific amount of raw materials by a certain date, thereby ensuring the uninterrupted operation of the enterprise.

Options are more often used to hedge risks arising from trading in the stock market. To understand the mechanism of their action, let's consider a small example. Suppose there is a package of securities that is being sold at the current price of 100 rubles. A certain investor, having analyzed the prospects of the package, came to the conclusion that in the next three months its price should increase by 50% and amount to 150 rubles. However, there is a high probability of financial losses if the forecast does not come true.

In this situation, the investor enters into an option contract with the holder of the package for a period of three months to sell the asset at a price of 100 rubles. For this right, he pays the owner of the securities 10 rubles. Now, if the forecast turns out to be correct and in the near future the share price rises to 150 rubles, the investor will be able to buy a package of securities for 100 rubles at any time before the expiration of the option contract and make a profit of 50 rubles.

If, however, an error was made during the analysis and the price of the package did not increase, but, on the contrary, decreased to 60 rubles, then the buyer of the option has the right to refuse the purchase. In this case, he will suffer a loss of 10 rubles, whereas in the absence of hedging the risk through the option, his loss would be 40 rubles.

The owner of securities can act in a similar way, concluding options for the right to sell an asset at its current value within a certain period. Third, fourth and fifth parties may be involved in the process - the same option can be resold to other market participants, who can dispose of it as an ordinary security.

Similar properties of forwards, futures and options are actively used in speculative games. In the twentieth century, the market began to rapidly become saturated with derivatives. As a result, its volume many times exceeded the market for real goods. This, according to many analysts, was the cause of the last crisis that gripped the global financial system at the beginning of this century.

Therefore, novice investors need to have a good understanding of what derivatives are and how to work with them correctly. Otherwise, illiterate use of such tools can result in serious losses.

Today, investors have at their disposal a lot of opportunities to make money both on changes in stock and currency prices, and on special financial instruments - derivatives.

The modern financial system includes a wide range of opportunities for the sale and acquisition of various assets. And derivatives are one of the most popular and liquid instruments among professional investors, but beginners have little understanding of this concept. Therefore, novice investors have a problem with using an unexplored tool, or they generally miss the opportunity to use it due to ignorance. This article explains in detail the concept of “derivative”, describes its capabilities and talks about the types of these instruments.

Derivatives (from English derivative) are called derivative financial instruments or agreements (contracts), thanks to which two parties can enter into a transaction for the right or obligation to use any underlying asset (for example, a block of shares). Those. under this agreement, one party undertakes to sell, buy, exchange or provide for use some goods or a package of securities.

When concluding an agreement in relation to any asset (it is called the basic one), the conditions for its use are determined and negotiated, which are prescribed in the agreement.

The wording is quite difficult to understand, but everything is much simpler. A simple example of a derivative is the purchase of equipment to order. In the contract with the selling company, the buyer indicates the name, brand, characteristics and exact price and delivery time. The seller must fulfill the contract on time and deliver the specified goods to the place of receipt. In this case, the underlying asset in the contract (derivative) is technology (for example, a computer).

With the help of this agreement you can protect yourself from price changes, because The seller is obliged to fulfill the contract at the strictly specified price of the goods. This can also be beneficial to the seller. For example, a certain rare computer configuration will be purchased under this agreement and will not remain in the warehouse.

From a legal point of view, this agreement allows the parties to accept obligations to fulfill the conditions and gives them certain rights, which is more convenient, in contrast to a regular purchase/sale. Most often, investors use derivatives to limit risks (hedging) and to make a profit on changes in the price of the underlying asset. Thus, the purpose of physically obtaining the asset is secondary. But, as in any type of speculative activity, the result of a financial transaction can be both profitable and unprofitable.

Derivatives market

The derivative, as a financial instrument, was formed in the 70s of the last century with the formation of the modern currency system. Before this, the financial instrument was used in relation to goods, then its use switched to currency, stocks, bonds, etc. Agreements were even concluded on debt securities of companies and some states.

In the Russian Federation, the formation of the derivatives market occurred in the 90s.

Types of financial instrument

In economics, derivatives are usually classified according to two criteria. First sign: what type of asset is used:

• Goods (precious metals, raw materials, grain).
• Bonds, shares, bills and other securities.
• Currency.
• Interest rates, indices.

Second sign: by type of transaction:

• Futures deal.
• Forward transaction.
• Option transaction.
• Swaps.

Futures deal- an agreement that must be executed at the agreed time and at the current price under the terms of the contract.

Forward transaction- an agreement that must be executed at an agreed time and at an agreed price (price at the time of conclusion of the contract). Unlike futures, the transaction price remains fixed.

An option provides the right to an asset (the ability to sell or buy), but does not obligate the holder to do so. For example, the holder of a block of shares in a company wants to sell it and finds a buyer, the latter can enter into an option-type contract with the holder. The buyer then transfers a certain amount of money to the seller, who transfers the shares. However, the option is limited in time and if the buyer does not meet the deadline and does not buy the shares, then the deposit remains with the buyer and he can find another buyer and sell him the block of shares.

Swap– a speculative instrument, which is a double transaction of buying and selling an underlying asset, but under different conditions. The main purpose of swaps is to obtain speculative profit.

What are derivatives used for?

In the modern financial market, investors use this financial instrument for two purposes:

• Hedging is insurance for risks.
• Speculative earnings.

Moreover, the goal of speculative earnings is much more common than risk insurance. Forwards and futures were described a little higher. Forwards are used just for insurance, because the price of the underlying asset under the contract remains unchanged. But futures contracts are used to obtain benefits and insurance against financial losses.

With the help of a futures contract, an investor can protect themselves in case the value of an asset decreases. In this case, he can sell futures and receive real money, covering the losses from a regular buy/sell transaction.

Many enterprises use futures for the supply of materials and raw materials for production. By concluding an agreement for the purchase/sale of raw materials on a specific date, they can secure production and uninterruptedly receive goods when concluding several futures contracts for different dates.

In the stock market, options are often used to hedge risks. For example, trader “A” analyzed the company’s stock chart and realized that the price of $10 per share is not the limit and the shares are undervalued. In a normal situation, Trader A could simply buy a certain amount of shares and wait for the price to rise, then sell and take a profit. But trader “A” decides to insure his investments and looks for trader “B” - a holder of shares in this company. He offers him a deal on the following terms:

• “You hold the stock for 3 months for me.”
• “I will make you a deposit of 20% of the cost of the desired package (for example, 1000 shares of $10 will cost $10,000, trader “A” makes an advance payment of $2000).”
• “After 3 months you deliver the shares to me and I pay the full price.”

In the case of an option, as discussed above, trader “A” can refuse to buy the shares if the purchase becomes unprofitable for him. At the same time, trader “B” does not return the prepayment to him. Trader “B” is in a winning position - he receives an advance payment, which will remain with him in any case, and if trader “A” refuses the deal, he will sell the stake to another trader. What are the possible ways?

• If the forecast is correct and the share price rises to $150, Trader A pays the remaining $80 per share ($20 he paid up front) to Trader B at any time before the contract expires and is left with a profit of $50.
• If the forecast does not come true and the price per share falls to $50, trader A is better off abandoning the purchase and losing $20 than losing $50 by buying a block of shares at the agreed price of $100 per unit.

In any case, the decision on the transaction is made by the buyer - he can either buy or refuse to purchase. The seller only has the obligation to deliver the goods to the buyer and, if the latter refuses, the seller can find another buyer.

Based on the possible paths of events in the given example, trader “A” insures increased losses with the help of derivatives and, in the event of an incorrect forecast, loses only the advance payment.

Conclusion

Beginning investors and financial market players should have a clear understanding of what a derivative is and how to work with it. A derivative contract has the following properties:

• The decision to close the transaction is made by the buyer.
• The seller is obliged to deliver the goods if he agrees to purchase.
• The buyer has the right to close the transaction only at the agreed time. In case of delay, the seller has the right to find another buyer.

With the help of derivatives, investors pursue the following goals:

• Risk insurance.
• Profits from speculation.

The simple essence of derivatives is to combine risk insurance with the possibility of profit. Those. You can buy a product that cost $100 a month ago and pay $40 today. Either you lose only the $10 advance payment rather than lose the cost of the price drop if you purchase the item in a regular deal.

Derivative financial instrument ) is an instrument that provides a market participant with the opportunity to liquidate his contractual obligation to another participant by paying or receiving the monetary difference between this and the opposite obligation, without violating the terms of the contract. Financial nature such an instrument follows from the inequality of these obligations, i.e. from the redistributive nature of the relationship between the parties to the derivative contract. Derivative character of this financial instrument follows from the method of settling obligations, the essence of which boils down to their offset without a formal legal refusal to fulfill them.

Derivative financial instruments are products of the activities of financial intermediaries who, based on the needs of market participants and various existing financial mechanisms, create an instrument with characteristics that are more acceptable to meet the economic goals of consumers, which the market asset that serves as the basis for this derivative does not have. Such characteristics may relate to the conditions and timing of payment of income on financial obligations, taxation issues, increasing liquidity and investment attractiveness, reducing transaction and agency costs, as well as other significant conditions.

The essence of the international derivatives market is most fully revealed in those functions, which he performs.

The defining, general function of the international derivatives market is further development and improvement of the use of capital in its fictitious form, not functioning directly in the production process and not being loan capital (credit). Derivative financial instruments both create fictitious capital and ensure its movement. At the same time, derivatives represent fictitious capital in its purest form. In other words, the emergence of derivative financial instruments was the result of active innovation activities associated with the development and expansion of the use of capital in its fictitious form.

The applied function of the international derivatives market has become financial risk management. Protection against risks of underlying financial assets, which underlies the creation and operation of derivatives, dialectically determined the increase in risk in their circulation. Accordingly, the constant attention of participants is aimed at monitoring and limiting new risks associated with the functioning of the derivatives themselves, including in credit, investment, foreign exchange and stock transactions. To perform this function of the international derivatives market, states are developing open operating standards, and participants in the international financial market are creating technical systems for regular risk assessment (solvency, liquidity, exchange rates, partners, etc.). The same purpose is served by analytical-historical and analytical-situational schemes for identifying and assessing the factors that determine risks.

Another application function of the international derivatives market is carrying out arbitrage and speculative operations through them.

Since derivative financial instruments are designed from the outset to be able to offset opposing obligations, they are not just traditional futures contracts, but also special trading and settlement mechanisms. However, they get their names from the type of fixed-term contract.

Derivative financial instruments can be classify in the following way:

• 1) by types of fixed-term contracts, on which the derivative is based (created):
  • – futures contracts;
  • – forward contracts;
  • – option contracts;
  • – swap contracts;
  • – types of the above contracts;
• 2) by standardizability :
  • – standard (futures and exchange options); non-standard (settled forwards, over-the-counter options,

• 3) by duration of existence :
  • – short-term (for a period of up to 1 year – as a rule, futures and exchange options, as well as settlement forwards);
  • – long-term (for a period of more than 1 year – settlement forwards, over-the-counter options, swaps);
• 4) by type of market relations :
  • – instruments based on a purchase and sale relationship (agreement);
  • – instruments based on other market contracts (loan agreements, lending agreements);
• 5) under the terms of a fixed-term financial transaction :
  • – firm (transactions that must be unconditionally executed – futures, forwards, swaps);
  • – conditional (options);
• 6) by trading systems :
  • – exchange (futures and exchange options);
  • – non-exchange, or over-the-counter (all others);
• 7) by types of quoted price of the underlying asset :
  • – interest;
  • – currency;
  • – stock;
  • – index;
• 8) if possible, delivery of underlying assets :
  • – supplied (commodity, currency, stock);
  • – non-deliverable (interest, index contracts);
• 9) according to execution form :
  • – contracts with the possibility of physical delivery of the underlying asset at the time of expiration;
  • – settlement contracts (there is no physical delivery at all).

Market competition brings to life new derivative financial instruments. The latter, in the most general form, are nothing more than new types of agreements between market participants, a characteristic feature of which are various combinations of transaction terms:

• – combination of assets, their quantitative and qualitative characteristics;
• – a variety of conditions and forms of settlements in terms of correlation of settlement time, payment flows and the grounds for their occurrence;
• – a combination of deliverability and non-deliverability of real assets underlying derivatives;
• – establishment of one or another procedure for fixing the price of the original asset at the time of concluding the contract and the procedure for its correlation with current market prices at the established settlement dates, etc.

In general terms, the most characteristic features derivative financial instruments and their markets are as follows:

• replacing the obligation to move (supply) a specific transaction asset with obligations to move capital;
• the transformation of derivatives into the most important source of profit for the majority of financial and credit organizations (modern banks in some cases receive up to 90% of their profit from operating in the markets of these instruments);
• the use of derivatives as the most important means of capital transfer, not so much on a national, but on an international scale;
• the multifunctional nature of the use of any derivative as a hedging instrument, speculation, arbitrage, etc.;
• the cross-industry nature of the use of the same derivative (very many market participants conducting their business in a wide variety of sectors of the economy can use each type of derivatives if economically necessary).

Function of collecting information, summarizing and analyzing the international derivatives market entrusted to the Bank for International Settlements. According to his classification, there are four type of assets, to which or a combination of which a derivative may be linked: foreign currency, shares; goods; interest rate on loans. The latter, in the context of the international financial market, are considered only in combination with the listed three financial assets. A characteristic feature of all of these derivatives is that when buying or selling them, the parties exchange not so much assets as the risks inherent in these assets. In this case, there are two main PFI type:

• – direct or outright contract – buying or selling without a corresponding cash transaction. Examples of outright transactions are forward and swap;
• – option or premium deal – the right to buy or sell, receive or deliver property in accordance with specified conditions. This right may or may not be exercised at the discretion of the contract owner. Failure to exercise an option results in monetary loss.

Many currency and financial derivatives cannot be clearly classified as direct or options contracts, since they are a combination of both.

Let's take a closer look derivatives of underlying assets.

Foreign exchange derivatives include forward contracts, currency swaps, vanilla options, as well as various exotic options (barrier and average). Currency derivatives are traded primarily on the over-the-counter market. Their standard currency is the US dollar.

Equity derivatives in most cases they are a retail investment product. A typical example is deposits indexed in accordance with stock market conditions. At the time of withdrawal of the deposit, the investor receives back the principal amount plus income on it, based on the growth of the stock index. Over-the-counter derivatives may exist on a specific corporate security, a basket of shares, or a stock index. Derivatives on stock indices occupy the main share of this market segment. Most often, equity derivatives are linked to one of four indices: Dow Jones; S &P500; FTSE100; Nikkei 225.

Commodity derivatives. In the commodity derivatives segment, crude oil contracts are the undisputed leader. As a rule, contracts are traded by both corporations and governments (OPEC member countries, for example). The high liquidity of the commodity derivatives market attracts a large number of speculators to this segment. Swaps and vanilla options are commonly used for commodity hedging. The second and third places are occupied by contracts for gold and aluminum.

Interest rate derivatives. This is the largest and most diverse part of the international derivatives market - up to 68% (Table 16.3).

Table 16.3

Classification of interest rate derivatives

Credit derivatives used in credit risk management strategies. They can complement or replace traditional risk management techniques such as portfolio diversification or credit limits. These are the only derivatives traded exclusively on the over-the-counter market. The main types of credit derivatives include defaulted asset swaps, credit options and total return swaps.

According to the British Banking Association, the volume of the credit derivatives segment reaches $600 billion. Its main participants are international banks. The main obstacle to the development of the credit derivatives segment in the international derivatives market is the lack of documentary standards, since there is no uniform legislation in the field of international lending in this market.

Forward contracts on short-term interest rates and bonds traded on an exchange as standard products are called interest rate futures. A typical example is a three-month interest rate futures contract. LIBOR. It is known as short-term futures (short sterling futures). By entering into a futures contract, companies fix the amount of their future debt or income from the future placement of funds on deposit.

Forward interest agreement forward rate agreement – FRA) is a contract for the exchange of payments on assets with a floating and fixed rate. The calculation is based on the nominal amount of the contract, which is not actually exchanged. Let us assume that the two parties have entered into FRA for three months, and its execution begins after 5 months. After 5 months, one party pays the other the difference between the fixed interest rate and the floating rate (usually LIBOR) based on 3 months. FRA widely used by banks to hedge interest rate risk, which arises due to different durations (terms) of assets and liabilities. Such contracts are traded exclusively in the over-the-counter derivatives market and form the basis for many over-the-counter interest rate derivatives.

Interest rate swap – one of the most common types of over-the-counter interest rate derivatives. This is a contract for the exchange of debt obligations with different periodic rates, each of which is calculated in relation to a specific amount. Swap transactions allow a borrower to exchange fixed-rate debt for floating-rate debt and vice versa. The amount is not physically exchanged, only interest payments are transferred. Interest rate swaps are the same as FRA traded only on the over-the-counter derivatives market.

Option on interest rate future is an option to buy or sell an interest rate future at a certain price. They are traded exclusively on the stock exchange. The most popular options are short-term sterling futures, Eurodollar and Svlibor.

Interest rate guarantee, cap, floor. Options on FRA are called "interest guarantee" (IRG) or percentage caplet (interest rate caplet). European call option FRA or "borrower" IRG" gives the loan recipient the right to fix a future maximum interest rate on the loan. Put option on FRA or "creditor" IRG", on the contrary, it allows the lender to lock in a minimum future rate on the loan. An interest cap is a contract that provides, under the terms of an option, for the payment of the difference between the floating interest rate on an asset and the maximum rate. An interest floor, on the other hand, guarantees the right to payment of the difference between the asset's floating rate and the agreed minimum rate. The combination of "ceiling" and "floor" is called "collar" (collar).

Swaption is a kind of swap option. It gives the buyer of the swaption the right to enter into an interest rate swap transaction at a certain date in the future at a fixed rate (strike rate) and on specific conditions. An option is called a "recipient swaption" if it gives the right to receive fixed interest payments on the swap, and a "payer swaption" if it gives the right to pay fixed interest payments and receive floating payments. There is a large volume of various swaptions traded on the international derivatives market. The basic ones are three-month and one-year options on two-, five- and ten-year swaps; 15-year options on 15-year swaps.

Bond options. There are forwards and options on national government bonds that are traded in both organized and over-the-counter markets. Contracts for corporate bonds and Eurobonds are traded on the over-the-counter market.

A combination of classic and exotic contracts. The main characteristic difference between an over-the-counter derivative financial instrument and an exchange-traded one is the non-standard nature of the main parameters of the former, which allows it to be adapted to the individual needs of market participants. Thanks to this flexibility, it is possible to enter into over-the-counter contracts with any forms and terms of settlement and execution, as well as other conditions, going far beyond the standard terms of existing exchange-traded derivative contracts.

In this case, contracts that are essentially identical in nature are compared, but only used by participants in either the exchange or over-the-counter market. For example, forwards and futures contracts are essentially the same type of forward contract. However, the first allows you to vary any contract terms, and the second allows its parties to agree only on the futures price, while any other parameters remain unchanged, standard.

In fact, the differences between exchange-traded and over-the-counter derivatives are not so much in the methods of fixing the parameters of a particular contract, but in the types of contracts used themselves. The fact is that exchange trading covers only a relatively small range of assets, professional participants, has strict rules, etc. It is impossible to trade “anything and everything” on exchanges, and such limitations do not allow the exchange to cover the entire market in terms of trading volumes, variety of assets, instruments, and participants. The number of types of contracts used in over-the-counter derivatives trading is many times greater than the number of types of exchange contracts. Moreover, over-the-counter derivatives are no longer based only on contracts that are permitted by the laws of the relevant countries, but also on contracts that do not yet fit into the current market legislation. Therefore, they cannot have traditional legal (judicial) protection of the interests of one party to the contract in the event that the other party, for some reason, suddenly violates the terms of the contract.

For example, the variety of over-the-counter forwards includes both their varieties in terms of the types of underlying assets, and completely new types of them, along with the classic form of a forward contract: contracts FRA (forward interest rate agreement) and contracts FXA (forward exchange agreement).

Another example is the many types of options contracts. It is known that a standard exchange option contract, based on a classic option contract, means that by paying a premium to the seller of the option, its buyer receives the right to choose. He can enter into a transaction in the underlying asset of the option at a predetermined exercise price (strike price) at any time before the contract expiration date (American option) or on the expiration date (European option) or abandon the transaction. In a standard option, the exercise price, the exercise date, and the asset of the transaction are fixed.

In over-the-counter options contracts, any terms can be changed in a variety of ways. Unlike classic options contracts, their new varieties are usually called “exotic”. Exotic options contract may include, among other things:

• execution at several fixed points in time (Bermuda option);
• payment of the premium not at the time of conclusion of the contract, but at the time of its expiration (Boston option or gap forward);
• delayed start of action (option with forward start);
• using another derivative financial instrument as an underlying asset (for example, swaptions (options on swaps), captions (options on caps), etc.);
• the choice by the buyer (owner) at a set point in time of what type of option this option will be: call or put (option with a choice, or option on an option);
• establishing a price level at which the option is canceled or, on the contrary, executed (barrier options);
• payment under an option of a fixed amount of money (cash or nothing option);
• payment under an option of the full value of the asset (“asset or nothing” option);
• establishing the dependence of the option payment on the maximum or minimum (“look-back” option) or average (“Asian” option) price value of the underlying asset achieved during the life of the option contract;
• receipt by the buyer at the expiration of the option of its maximum intrinsic value, calculated for a certain day chosen by him during this period, or receiving the same intrinsic value, but only on the date of its expiration;
• establishing the dependence of option payments on the prices of several underlying securities (“basket” option);
• a payment that does not have a linear (proportional) connection with the price of the underlying asset (strengthening option);
• payment of an option in a currency different from the currency of the original underlying asset.

You can combine the above features, as well as create any new characteristics of option contracts to satisfy the “exotic” needs of market subjects ad infinitum.

Swap contracts are based either on firm fixed-term (forward) or conditional (option) contracts. Therefore, they also allow for the existence of variations in the original design relative to its “standard” content (the latter provides for the payment of differences in cash flows based on various forms of fixing exchange rates, interest rates, stock and commodity prices). We can also talk about types of swaps in terms of underlying assets, which are even more numerous than in the case of option contracts. This is due to the fact that the latter differ most not by the type of asset (the bulk of options are on shares), but by the types of conditions, or designs, of over-the-counter option contracts. For swaps, the options for contractual terms are not as numerous as in the case of exotic (OTC) options. Swaps, in particular, may allow the following “exotic” varieties:

• deferment of the beginning of its effect (forward swaps);
• a combination of netting payments with exchanges of the principal amounts of the transaction, if we are talking about different assets, for example, different currencies or different goods (securities);
• exchange of payments in one currency (even if they relate to asset prices in different currencies) or in two different currencies;
• amortization of the swap principal over time based on a specified fixed schedule (amortizing swap) or based on changes in a specified stock index (index amortizing swap);
• extension of the validity period of the swap or its cancellation (i.e. the presence of option features), etc.

According to the IMF, exotic instruments now account for about a third of the gross market value of all over-the-counter derivatives. Most over-the-counter derivative financial instruments are still based on classic forms of forward or option contracts and differ little from their exchange-traded counterparts. However, for the convenience of the over-the-counter market, their main parameters are standardized in advance, or rather, typed, i.e. the feature itself remains standard, and its quantitative parameters can be changed in accordance with the requests of a particular client. All this reflects a trend towards blurring the distinction between exchange-traded and over-the-counter derivatives. However, the boundary between them cannot completely disappear due to the fact that all market transactions are unlikely to ever lose their individuality.

Turnover and dynamics of the international currency and interest rate derivatives market hide the discrepancy in the development of these two segments: the market for foreign exchange instruments has decreased in turnover, while the turnover of the interest rate derivatives market has increased.

The decline in the foreign exchange derivatives market is associated with the low turnover of foreign currency in the spot market segment of the financial market, which experienced significant changes in 2000–2005. A particularly significant factor was the introduction of a single European currency, which led to a narrowing of contracts in the currencies of the euro area countries. In contrast, the growth in interest rate market volumes was driven by an upward trend in the interest rate swap market, which was a consequence of changes in hedging and trading activity in the U.S. equity market and the creation of a broad, liquid market for euro-denominated interest rate swaps.

Despite the decrease in the number of foreign exchange market instruments, the turnover in this segment continues to exceed the turnover of the interest rate instruments segment, mainly due to the short-term nature of contracts of the first type. However, if the market for interest-bearing instruments continues to develop at the current pace, it will soon become equal to the market for foreign exchange instruments.

Derivatives usage ranking data shows the rapid expansion of the credit derivatives market. This market is growing rapidly due to diversification of tools and improvements in market infrastructure. The decline observed in the turnover of the currency derivatives market varies greatly among individual categories of instruments. Thus, the turnover of conventional forward contracts and currency swaps decreased slightly (by 9% over the past five years), and the turnover of currency options and foreign exchange swaps fell by 30% over the same period.

The expansion of the interest rate contracts segment is caused by an upward trend in the interest rate swap market. The introduction of the euro created a large and liquid market for euro-denominated swaps. Trading volume in forward contracts also increased.

A derivative is a derivative financial instrument derived from an underlying asset, such as a commodity or a corporate share. Its main difference from a simple purchase and sale agreement, under which ownership is transferred, a derivative only certifies the right or obligation (or both) to buy or sell the underlying asset in the future.

Derivatives trading is based on trading risks that arise from possible changes in stock prices, exchange rates, interest levels, and commodity prices. The nominal value of financial instruments traded on the global derivatives market already exceeds $100 trillion, and the value of transactions concluded on it is approaching $500 billion per year.

• The main types of derivatives are:

1. 
   options(options) and warrants(warrants). These types of derivatives give the owner the right (but not the obligation) to sell or buy certain assets at a price fixed in the contract;
2. futures(futures), Derivatives standardized for exchange trading forwards(forwards), - contracts for the supply of various assets in the future (goods, currency, securities) at a price fixed in the contract;
3. swaps(swaps) - Derivatives - contracts for the exchange of assets or payments within a certain period at a pre-agreed price.

The derivatives market is closely related to the foreign exchange market, primarily due to the fact that both of these markets are associated with the exchange of one currency for another or securities in one currency for securities in another currency. Most of the derivatives market goes to currency futures and swaps (usually short-term, but there are also long-term ones), as well as interest rate futures, options and swaps, which are based mainly on contracts for the exchange of various securities, or more precisely, income from them.

The market mainly offers transactions with swaps, futures and options. Futures are an agreement for the purchase and sale of assets in the future, it is concluded according to the rules established by the exchange. Market rules make it possible to provide free trading for an unlimited number of participants, which is why the futures market has greater liquidity.

It is of great importance that if a condition is added to a futures contract that for a certain fee you can buy/sell a security at a pre-agreed price or terminate the transaction, the future turns into an option.

In this case, a person who, for example, entered into a futures contract or an option on a futures contract to open a market position, but did not liquidate this position by counter-selling, takes, as stock exchange specialists usually say, a long position. Conversely, a person who sells a futures contract or an option on a futures contract to open a market position and does not liquidate that position with a counter purchase is taking a short position.

Thus, the considered transactions perform the function hedging, those. limiting risks when conducting various exchange operations.

Derivatives are securities, namely derivative financial instruments that give the right to perform certain actions with the assets that underlie them and are called basic, both in the present and in the future.

Broad definition that requires clarification:

A derivative financial instrument does not mean the asset itself (for example, a commodity) that underlies such a contract, but only the right to perform actions with this asset. This is one of the fundamental differences between the spot market and the derivatives market: in the spot market, if you bought a share, then you “have a thing” - the share can be sold, it can be given as a gift, and even pledged to the bank, receiving money for it ( repo transactions).

But derivatives (even though these contracts cost a lot of money) from the point of view of property represent... don’t understand what. Until the contract for the supply of goods is fulfilled, it will not be possible to actually “collect” any property under this contract (and such contracts have a validity period of 3, 6, or less often – 9 months). Theoretically, the only thing that can be done with this contract while the investor has it in his hands and its validity period has not expired is to monetize it again, that is, simply sell it, receiving (in theory) for it what was at one time in it is invested.

What actions can be performed with the underlying assets within the framework of a derivative contract? Obviously, deliver or accept something (that is, buy). In other words, buying a derivative contract means acquiring the right to deliver or purchasing the underlying asset. It may seem that, for example, the acquisition of a derivative contract and the acquisition of the asset itself are “two big differences.” However, it is not. Derivatives simply mean staggering the payment and delivery of the underlying asset over time (the same 3, 6, or less often – 9 months).

For example, purchasing a contract for the supply of a product in the future actually means selling this product. And the sale of the right to purchase it... is also its sale!

The essence of derivatives

The formulation of the fact of timing of delivery and payment plays a key role in understanding the essence of derivatives. As confusing as the definition may sound, at their core, derivative contracts are simply prepaid transactions. And from this already follow various opportunities for buyers and sellers. Eg:

• Delivery of the underlying asset under this contract must certainly take place.
• Or one of the parties, determined in advance, gets the opportunity to refuse to fulfill it if the economic conditions for this party do not seem favorable.

Amazing, isn't it? Who might need a contract for the supply of something in at least 3 months, but at the current price, and even though one of the parties to the transaction may refuse it? However, the demand for precisely such terms of derivative contracts is clearly demonstrated in the following example:

Let's say subject A suggests that cotton, currently priced at $100, is undervalued, and logically it should cost more. The rational economic behavior of speculator A would be to buy some of this “white gold” according to his own forecast, wait for the cotton market to rise, and then sell it at a profit. But “A” wants to play it safe: he is looking for a cotton seller – subject “B”, with whom he negotiates a price and formulates the following conditions: let me give you an advance payment, 10 percent, so that you can supply me with cotton in 3 months. At the same time, he (subject “A”) reserves the right to refuse to pay extra and pick up cotton if for some reason it becomes unprofitable for him, however, the prepayment made in any case to subject “A” from “B” " is no longer coming back.

This is beneficial for subject “B”: he receives a guaranteed advance payment, and if “A” refuses to pick up the goods that he will “fit” for him in 3 months, well, it’s your choice, Mr. Buyer, I’ll sell it to someone else! What happens in the end?

Let’s say the forecast on which the whole “combination” was based came true and cotton rose in price to $200 in 3 months. In this case, “A”, with a clear conscience, pays “B” the remaining $90 (90% after the initial 10% advance payment) and for the resulting $100 takes the goods, which already cost $200.

But what if suddenly the forecast does not come true and the cost of cotton drops to $40. In this case, it is more profitable for “A” to completely refuse to pay extra under the contract. After all, if he pays an additional $90, he will receive (in the end, for the same $100) a product that costs $40 - the loss will be as much as $60! And if he refuses to complete the transaction, he will only lose the advance payment - $10.

Subject “A” initially purchased cotton in order to greedily profit from the increase in its market (exchange) value. That is why he invented such “interesting” terms of delivery and settlements, where the decision to complete the transaction remains with the buyer. But why should the cotton supplier agree to this? Doesn’t he understand that if he stays with cheaper cotton, he will lose exactly what he is afraid of losing “A”?

Yes, he understands everything. Simply, according to the terms of the derivative contract (and this is exactly what it is), the right to make a decision on completing the transaction lies with the holder of this contract (its buyer). The writer (his seller) bears only one delivery obligation. But nothing prevents “B” from acting as a buyer of the obligation to supply cotton under another agreement and independently deciding whether it makes sense to make the supply.

Types of derivatives

The main examples of derivatives (that is, contracts, transactions, delivery and payment for which are spread over certain periods of time) are:

• Futures contracts;
• Options;
• Forward contracts.

How are they different? Here is the example given in the previous section - this is a typical option.

Option– this is a security that gives the right (but not the obligation) to its acquirer to carry out a transaction with the underlying asset after a specified standard period of time, but at the price at the time of acquisition of the option (exercise price).

If it is impossible not to complete the transaction, then in this case we are talking about futures.

Futures is a security that obliges its acquirer to carry out a transaction with the underlying asset after a specified standard period of time, but at the price at the time of purchasing the option (at the exercise price).

And here the aspirations of trade participants change somewhat. If the contract cannot be abandoned, it means that if there is no particular desire to deliver on it, you need to either sell it or compensate by buying exactly the same one, only not for purchase (if you have an obligation to buy), but for sale. And this somewhat intensifies futures trading.

Both futures and options are standard securities trading on organized markets (currency, stock exchanges). Issues of shares and bonds are carried out by specific legal entities - participants in the financial market. But options with futures can be issued... by anyone who wants to assume the right/obligation to deliver or purchase the underlying asset.

If the underlying asset– shares, then its popularity and attractiveness from the perspective of market participants is determined precisely by the amount of turnover under derivative contracts, the volume of which collectively characterizes the reliability and liquidity of the issuer of the securities itself, that is, the legal entity itself.

But forward contracts- These are less standard, non-exchange contracts, which, however, have all the same qualities and characteristics as market options. As a rule, forward contracts are concluded if the participants want to include certain additional conditions in them, and also if their amount significantly exceeds the “market standard” (100 thousand units of the underlying asset).

Conclusion or what are the main functions of derivatives

Both main functions of derivative contracts can be seen in the example above:

Risk hedging

Hedge – insurance. But only, not in terms of turning to the services of a professional insurer (an insurance company issuing a policy), but, essentially. That is, the mechanism of the transaction itself insures its parties (or only one of the parties) from increased losses. In the example given, it was the cotton buyer – subject “A”. But this could easily become subject “B” if he buys an option for the right to deliver from someone. Only then will he refuse the deal if the price rises, since the supplier benefits from a fall in price.

Speculation

Futures here simply have no equal. A pledge or prepayment under a contract (filling) essentially forms a leverage – a multiplier that increases the scale of the financial result of changes in the market value of an asset. After all, if the price changes, not only for the prepaid part, but for the rest of the contract too. And this quality makes futures an excellent tool for implementing trading strategies literally “at high stakes.”

So, derivatives: what are they in simple words? Perhaps it’s a compact combination of the first and second: so that those crayfish that were available yesterday for 5, can be bought tomorrow, and paid today for 3...