Question

what determines the use and price of futures/forward and plain vanilla options

Answer 1

Answer:-

Derivatives are securities whose price is determined by the underlying asset. The underlying asset can be the bond, commodity, stock, etc. Derivative is a contract between two parties to buy or sell the underlying assets at a specified price and before the expiration date. The derivatives can be mainly four types: Forward, Future , options and swap. Derivatives are mainly used to reduce the possibility of risk.

The future/ forward contracts are mainly used by the businesses and investors to hedge risk.  Also in future/ forward contract the participants can make risk free profit through arbitrage when they feel forward is mispriced. Arbitrage means buying and selling of securities in the same or different markets. The future contact can be used for speculation. Speculation means the buying and selling of underlying asset with the hope of making profit. Forward contracts are traded between two parties directly so that they are not traded on exchange but future contracts are traded on stock exchange.

The price of Future is determined by its spot price and also the carrying cost and opportunity cost. The price of forward is determined by its spot price of the underlying asset and also benefit such as interest and dividend that is paid by underlying asset and carrying cost are also taken into account for determining the price.

Plain Vanilla option are options with no special features. The options can be of two types call and put options. Call option gives holder right to purchase an asset and Put option gives holder the right to sell an asset at specified price and on or before specified time. . Vanilla options are used by Individuals, companies, and institutional investors to hedge risk or speculate the price movements of financial instruments. The main advantage of option is that it give the right but not the obligation to buy the security.

The price specified in option is called strike price or exercise price. The purchase price of option is called premium. The price of plain vanilla option is determined by stock price, strike price , time value and volatility. Volatility measures the price fluctuations in the security.