Securities & Trading Basics – Lesson 8: Derivatives (Options & Futures) Now that you understand risk management, let’s explore derivatives, financial instruments that derive their value from an underlying asset (stocks, commodities, or indices). This lesson covers: 1. What Are Derivatives? 2. Options Trading Basics 3. Futures Contracts 1. What Are Derivatives? A derivative is a contract whose price is based on an underlying asset. Derivatives are used for: Hedging: Protecting against price movements. Speculation: Betting on price changes for profit. Leverage: Controlling large positions with less capital. Common Derivative Types: Options: Right (but not obligation) to buy/sell an asset. Futures: Obligation to buy/sell at a fixed price in the future. Swaps & Forwards: Custom contracts between two parties (used by institutions). 2. Options Trading Basics A. What Is an Option? An option is a contract that gives the holder the right (but not the obligation) to buy or sell an asset at a specific price before a certain date. Option Type Right to Used For Call Option Buy the asset Bullish bets (expect price increase) Put Option Sell the asset Bearish bets (expect price drop) B. Key Option Terms Strike Price: The price at which the asset can be bought/sold. Expiration Date: The last day the option is valid. Premium: The cost of buying the option. Intrinsic Value: Difference between the stock price and strike price. Time Decay (Theta): Options lose value as expiration nears. C. Basic Options Strategies Covered Call: Selling calls on stocks you own for extra income. Protective Put: Buying puts to hedge against a stock decline. Straddle: Buying both a call and put to profit from volatility. 3. Futures Contracts A. What Is a Futures Contract? A futures contract is an agreement to buy or sell an asset at a predetermined price on a future date. Unlike options, futures must be settled at expiration. Example: A gold futures contract requires buying 100 ounces of gold at $2,000/oz on a set date. B. Common Futures Markets Stock Index Futures (S&P 500, Nasdaq) – Used by traders to hedge or speculate on stock market direction. Commodity Futures (Gold, Oil, Wheat) – Used by producers and investors to hedge against price swings. Currency Futures (EUR/USD, JPY/USD) – Used in forex trading. C. Futures vs. Options Feature Futures Options Obligation Must fulfill contract Can choose to exercise Risk Higher (unlimited losses) Limited to premium paid Use Case Hedging, speculation Hedging, speculation, income strategies
Next Steps
Now that you understand options and futures, the next lesson will cover technical indicators and how traders use them to time the market.