Question

Essay on differences between two financial derivatives.

Answer 1

Financial derivatives are specialized products that derives their value from an underlying security or asset class . As such these intangible instruments acts as a proxy for the real assets from whom their actual value is derived by various pricing mechanisms

To differentiate between derivatives , the simplest of the financial derivatives , the Futures and Options are taken as example

Futures	Options
Futures are contracts between two parties where one party agrees to buy the asset and the other partly agrees to sell the asset at a specified price in a future date	Options are the choice of exercise where the buyer of the option has the right to execute the contract at a strike price
Future contacts do not have any premium associated	Premiums are associated with options
Traded usually on high margin based on the full contract value	Traded on low margins based on only the premium associated with the underlying asset
Used for trading purpose and speculative trades involving high risk adjusted rewards	Most popular instrument for hedging the portfolio
Cash settlements as well as physical delivery based settlements can be done on future contracts	Only cash settlements are done on the option contracts
Has exposure to both high profits and loss	Has very high profit potential and losses are limited only to the amount of premium paid
Has very high risk associated for both the parties	Risk profiles are limited
Pricing is determined solely on the expiry price of the underlying asset	Premium pricing is based on complex option valuation models which depend on the Volatility on the underlying asset

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