Equity Derivatives

Options

An option is a contract that gives an investor the right to trade shares of stock at a particular price (strike price).

Options can be used by investors who already own shares of stock (referred to as a covered option),but can also be used by investors who do not currently own stock. The option contract specifies whether the option is a call or put, the number of shares in question, the strike price, the contract’s expiration date, and any terms related to settling a closed position. The price of the option, referred to as the premium, varies according to the expiration date, the volatility of the stock and the strike price.This type of equity derivative can be used to hedge risk.

Futures

A future is a contract between two parties in which one party (the buyer) agrees to buy the underlying security at a future date and price. While similar to an option, purchasing a futures contract creates an obligation instead of a right. In other words, the buyer must purchase the stock when the futures contact reaches the agreed upon date. The buyer does not have the option of letting the contract expire without making the purchase. The seller also must sell the stock. Futures are traded on an exchange.