Derivatives

what are derivatives

financial instruments whose value is derived from an underlying asset

what are forwards

customized contracts to buy/sell an asset at a future date at a future predetermined price

what are futures

standardized contracts traded on exchanges, similar to forwards but with daily settlement

what are options

contracts that give the right but not obligation to buy/sell an underlying at a set price before or at expiration

what are swaps

agreements to exchange cash flows or financial instruments, typically interest rates or currencies

what are the characteristics of a future contract

vast majority of initiated futures contracts do not lead to delivery

what are the 3 critical days of a future contract

• first notice day → accept or not delivery

• last trading day → final day on which trading for the contract is allowed

• last notice day → last day for arrangements for the delivery

what is the position closing in future contracts

entering trade opposite to the original position

• initial long → you close position by selling and identical futures contract

• initial short → you close position by buying and identical futures contract

what are covered calls

• Owns the underlying stock

• Sells (writes) a call option on that same stock

• Goal: Earn income from option premium

• Risk: Stock falls → you lose on stock, but keep premium

• Reward: Limited upside (stock can be called away)

what are protective puts

• Owns the underlying stock

• Buys a put option on that stock

• Goal: Limit downside risk

• Risk: Limited (to stock price − strike + premium)

• reward: Unlimited upside from stock

what are fiduciary puts

A fiduciary put is a synthetic investment strategy that guarantees a minimum return — combining:

1. A risk-free bond (zero-coupon bond), and

2. A long European put option on a risky asset (e.g., a stock)

what are naked calls

Sell a call option, without owning the underlying asset (e.g., stock or ETF)

• max profit = premium

• max loss = unlimited

• bias: bearish

what are naked puts

Sell a put option, without holding cash or buying power to buy the stock if assigned

• max profit = premium

• max loss = large

• bias: bullish

what is a collar

A collar is an options strategy designed to protect downside risk while capping upside gains. It combines:

1. Owning the underlying stock

2. Buying a put option (downside protection)

3. Selling a call option (limits upside, helps finance the put)

what is a straddle

A straddle is an options strategy where an investor buys both a call and a put on the same underlying asset, with:

• The same strike price

• The same expiration date

This is a neutral strategy that profits from big price movements — in either direction.