How do equity derivatives work?

Equity derivatives are financial instruments that derive their value from an underlying equity security, such as stocks or shares. These derivatives allow investors to speculate on the price movements of the underlying equity without actually owning the asset.

There are various types of equity derivatives, including options, futures, and swaps.

Options give the holder the right, but not the obligation, to buy (call option) or sell (put option) the underlying equity at a predetermined price (strike price) within a specified period of time. The buyer pays a premium to the seller for this right.

Futures contracts, on the other hand, obligate the buyer to purchase the underlying equity at a predetermined price and date in the future. The seller is obligated to deliver the equity at the agreed-upon price and date. Futures contracts are standardized and traded on exchanges.

Swaps involve the exchange of cash flows based on the performance of the underlying equity. For example, in an equity swap, one party may agree to pay the other party the difference between the returns of a specific equity and a predetermined benchmark.

Overall, equity derivatives provide investors with opportunities to hedge against price fluctuations, speculate on future price movements, and manage risk exposure in the equity markets.