Keeping this lack of awareness in mind, we have decided to give basic information about this new concept of trading. Put in a question format, it answers most of the queries of the investors and they can thus gain some insight into the actual working of derivatives trading. A derivative is an instrument whose value is determined from value of one or more underlying which could be commodity, forex, precious metals, bonds, loans, stocks, stock indices, etc. Four derivative instruments are forwards, futures, options and swaps. A forward contract is a tailor-made agreement between two parties and where date of settlement and price is agreed upon in advance.
Settlement takes place after the normal delivery date.
These are bilateral contracts and each contract is unique in terms of size, date, asset size and quality. The contract price is not transparent as it is not publicly disclosed. While in futures contract, trades take place on the exchange and the terms are standardised by the exchange. Gearing is leveraging of results where initial cash-flow in taking a position is less than the value of the position. Higher the gearing, higher the risk.