Global Finance · Chapter 16
Options and Derivatives
Understanding financial instruments that derive their value from underlying assets — stocks, bonds, commodities, or currencies.
What Are Derivatives?
A derivative is a financial contract whose value depends on an underlying asset. Common derivatives include options, futures, swaps, and forwards. They are used for hedging risk or speculating on price movements.
Key fact: The global derivatives market exceeds $600 trillion in notional value — far larger than the global stock market.
Options Contracts
An option gives the buyer the right, but not the obligation, to buy or sell an asset at a set price (the strike price) before a specific date (expiration).
| Type | Right Granted | Used When You Expect |
|---|
| Call Option | Buy the asset at strike price | Price to rise |
| Put Option | Sell the asset at strike price | Price to fall |
Example: You buy a call option on Apple stock at $200 strike price. If Apple rises to $230, you profit $30 per share minus the premium paid. If it stays below $200, your only loss is the premium.
Futures Contracts
Futures obligate both parties to buy or sell an asset at a predetermined price on a future date. Unlike options, there is no choice — both sides must fulfill the contract.
- Commodity futures: oil, gold, wheat, corn
- Financial futures: S&P 500 index, Treasury bonds
- Currency futures: EUR/USD, JPY/USD
Hedging vs. Speculation
Hedging uses derivatives to reduce risk. An airline buys oil futures to lock in fuel costs. A farmer sells wheat futures to guarantee a sale price before harvest.
Speculation uses derivatives to profit from price movements without owning the underlying asset — higher reward, but also higher risk.
Important: Derivatives can amplify both gains and losses through leverage. Always understand your maximum possible loss before entering a derivatives position.
The Greeks: Measuring Options Risk
Options traders use "the Greeks" to measure how an option's price changes:
- Delta — how much the option moves per $1 move in the stock
- Theta — time decay (options lose value as expiration approaches)
- Vega — sensitivity to volatility changes
- Gamma — rate of change of delta
Chapter 16 Summary
- Derivatives derive their value from an underlying asset
- Call options = right to buy; Put options = right to sell
- Futures obligate both parties to transact at a future date
- Derivatives are used for hedging (risk reduction) or speculation
- The Greeks measure different dimensions of options risk