Financial Derivatives Explained | What are Financial Derivatives? Options and Futures
Channel: Farhat Lectures. The # 1 CPA & Accounting Courses
Date: 2020-06-27

In this video, I explain financial derivatives.  A derivative is a financial security with a value that is reliant upon or derived from, an underlying asset or group of assets. A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, index or security.

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Futures, options, and related derivative contracts provide payoffs that depend on the values of other variables, such as commodity prices, bond and stock prices, interest rates, or market index values. For this reason, these instruments sometimes are called derivative assets: Their values derive from the values of other assets.
A call option gives its holder the right to purchase an asset for a specified price, called the exercise or strike price, on or before some specified expiration date. A May call option on Apple stock with exercise price $140, for example, entitles its owner to purchase Apple stock for a price of $140 at any time up to and including the option’s expiration date in May. Each option contract is for the purchase of 100 shares, with quotations made on a per share basis. The holder of the call need not exercise the option; it will make sense to exercise only if the market value of the asset exceeds the exercise price.
When the market price exceeds the exercise price, the option holder may “call away” the asset for the exercise price and reap a benefit equal to the difference between the stock price and the exercise price. Otherwise, the option will be left unexercised. If not exercised before the expiration date, the option expires and no longer has value. Calls, therefore, provide greater profits when stock prices increase and so represent bullish investment vehicles.

In contrast, a put option gives its holder the right to sell an asset for a specified exercise price on or before a specified expiration date. A May put on Apple with exercise price $140 entitles its owner to sell Apple stock to the put writer at a price of $140 at any time before expiration in May even if the market price of Apple is lower than $140. Whereas profits on call options increase when the asset increases in value, profits on put options increase when the asset value falls. The put is exercised only if its holder can deliver an asset worth less than the exercise price in return for the exercise price.

Futures Contracts
A futures contract calls for delivery of an asset (or, in some cases, its cash value) at a specified delivery or maturity date, for an agreed-upon price, called the futures price, to be paid at contract maturity. The long position is held by the trader who commits to purchasing the commodity on the delivery date. The trader who takes the short position commits to delivering the commodity at contract maturity.