hedging using derivatives,options strategies
...r an agreed period of time based upon a notional amount of principal. Role of Derivatives 1. Risk Management As options and futures are related to prices of the underlying spot market goods, they can be used to reduce or increase the risk of investing in the spot items. This is termed as hedging. 2. Price discovery Future markets are an important means of obtaining information about investors? expectations of future prices. Many believe that price of a future contract is the expected future spot price. 3. Operational Advantages These entail lower transaction costs. Derivative Markets have more liquidity than spot markets. They also allow investors to sell short more easily. 4. Greater Market Efficiency Society benefits because the prices of underlying goods more accurately reflect the goods? true economic values as it reduces the presence of profitable arbitrage opportunities. 5. Speculation Derivatives provide an alternative means of speculating. Instead of buying the underlying stocks or bonds, an investor can buy these derivative contracts. OPTIONS There are options on future contracts, foreign currencies etc. but we will be dealing with options on the financial assets such as stocks or bonds. We will be starting of with defining an ?Option?. An option is a contract between two parties, a buyer and a seller, in which the buyer purchases from the seller the right to buy or sell an asset at a fixed price. As in any contract, each party grants something to the other. The buyer pays the seller a fee called the premium. The seller grants the buyer the right to buy or sell the asset at a fixed price. Options are the most versatile trading instrument ever invented. Since options cost less than purchasing the underlying stock, they provide a high leverage approach to trading that requires a smaller investment of capital and can reduce the overall risk exposure. Options can ...