Equity Derivative

An equity derivative is a financial instrument whose value is derived from the value of an underlying equity security. Equity derivatives can be used to speculate on the future price of an equity security, to hedge against the risk of an existing equity position, or to generate income.

There are two main types of equity derivatives: options and futures. Options give the holder the right, but not the obligation, to buy or sell an underlying equity security at a specified price on or before a specified date. Futures contracts obligate the holder to buy or sell an underlying equity security at a specified price on a specified date.

Equity derivatives can be used to speculate on the future price of an equity security by buying a call option or selling a put option. A call option gives the holder the right to buy an underlying equity security at a specified price on or before a specified date. If the price of the underlying equity security rises above the strike price of the call option, the holder can exercise the option and buy the underlying equity security at the strike price. The holder will then make a profit on the difference between the strike price and the market price of the underlying equity security.

A put option gives the holder the right to sell an underlying equity security at a specified price on or before a specified date. If the price of the underlying equity security falls below the strike price of the put option, the holder can exercise the option and sell the underlying equity security at the strike price. The holder will then make a profit on the difference between the strike price and the market price of the underlying equity security.

Equity derivatives can also be used to hedge against the risk of an existing equity position. For example, a company that owns a large number of shares of a particular stock may buy put options on that stock to protect itself against the risk of a decline in the stock price. If the stock price falls, the company can exercise the put options and sell the stock at the strike price, thereby limiting its losses.

Equity derivatives can also be used to generate income. For example, a trader may sell call options on a stock that he or she does not own. If the price of the stock rises above the strike price of the call option, the trader will lose money on the trade. However, if the price of the stock remains below the strike price of the call option, the trader will keep the premium that he or she received for selling the call option.