Forex derivatives meaning

Over-The-Counter - OTC.

What is 'Over-The-Counter - OTC'

Over-the-counter (OTC) is a security traded in some context other than on a formal exchange such as the New York Stock Exchange (NYSE), Toronto Stock Exchange or the NYSE MKT, formerly known as the American Stock Exchange (AMEX). The phrase "over-the-counter" can be used to refer to stocks that trade via a dealer network as opposed to on a centralized exchange. It also refers to debt securities and other financial instruments, such as derivatives, which are traded through a dealer network.

BREAKING DOWN 'Over-The-Counter - OTC'

Popular OTC Networks.

The OTC Markets Group operates some of the most well-known networks, such as the OTCQX Best Market, the OTCQB Venture Market and the Pink Open Market. These markets include unlisted stocks that are known to trade on the Over the Counter Bulletin Board (OTCBB) or on the pink sheets. Although Nasdaq operates as a dealer network, Nasdaq stocks are generally not classified as OTC because the Nasdaq is considered a stock exchange. Conversely, OTCBB stocks are often either penny stocks or are offered by companies with bad credit records.

Securities on OTC Networks.

Stocks are usually traded OTC because the company is small and cannot meet exchange listing requirements. Also known as unlisted stock, these securities are traded by broker-dealers who negotiate directly with one another over computer networks and by phone. The dealers act as market makers, and the OTC Bulletin Board is an inter-dealer quotation system that provides trading information.

American depository receipts, which represent shares in an equity that is traded on a foreign exchange, are often traded OTC, because the underlying company does not wish to meet the stringent exchange requirements. Instruments such as bonds do not trade on a formal exchange and are also considered OTC securities.

Most debt instruments are traded by investment banks making markets for specific issues. An investor must call the bank that makes the market in that bond and asks for quotes to buy or sell a bond.

What Is A Derivative?

Within the fields of trading and finance, a derivative is considered to be an instrument used for investment via a contract. Its value is “derived” from (or based upon) that of another asset, typically referred to as the underlying asset or simply “the underlying.” In other words, a derivative contract is an agreement that allows for the possibility to purchase or sell some other type of financial instrument or non-financial asset. Common types of derivative contracts include options, forwards, futures and swaps.

Among the many types of underlying assets that are commonly used with derivatives include equities or equity indices, fixed-income securities, currencies, commodities, credit events and even other types of derivatives. Derivative contracts are typically used by investors for the purpose of speculating, or hedging, against possible future changes in market factors, and thus against the future market value of an underlying asset.

The special value of derivatives contracts compared to contracts for direct trade of underlying assets is that they allow transference of risks from individuals or entities less willing or able to manage them to those more willing or able to manage them. Also, derivatives contracts often require only small or even no initial monetary investment, and they’re settled at a future date from the buyers’ and sellers’ adherence to the contract.

Derivatives are subject to “net settlement” through delivery, or non-delivery, of the underlying asset. However, positions in transactions involving derivatives contracts are frequently closed before an underlying asset is delivered to a buyer. 1) Retrieved 27 November 2015 bis. org/ifc/publ/ifcb35a. pdf.

Use of Derivatives in Forex Trading.

Much of currency trading is done on what is called the spot, or “cash,” market where currency pairs are bought and sold at their present value and delivered within a two-day period. The period is based on the time for the transaction to clear in the accounts of the respective participants in the trade. Currencies, however, are commonly traded as part of derivative contracts in futures, forwards, options and swaps. 2) Retrieved 27 November 2015 phil. frb. org/research-and-data/publications/business-review/1995/brmj95gh. pdf.

Types of Forex Derivatives.

Futures Contract.

A futures contract is an agreement to buy or sell a quantity of a currency at a pre-established price on a particular date in the future. Profits and losses on a futures contract are realised and paid out at the end each day. Currency futures contracts are traded in standard sizes and have set maturity dates, generally falling on the third Wednesday of March, June, September and December. Participants in currency futures contracts can be “hedgers” seeking to lock in a price to diminish the risk of a future price change, or they can be “speculators” who enter into a trade seeking potential gains.

Forward Contract.

Like a futures contract, a forward contract is an agreement to buy or sell a quantity of a currency at a pre-established price on a particular date in the future. Differently from a futures contract, however, profits and losses on a forward contract are realised and paid out only when the contract expires. Forward contracts are traded on an over-the-counter basis between two parties, and unlike futures contracts, these are not regularly bought and sold on exchanges.

Option Contract.

A currency option gives an investor the right, but not the obligation, to buy or sell a quantity of currency at a pre-established price on or before the date that the option expires. The right to sell a currency is known as a “call option” and the right to buy is known as a “put option.” Options can be understood as a type of insurance where buyers or sellers can take advantage of more favourable prices should market conditions change after the option is purchased.

Buying a call option, for example, can be used as insurance against the risk of a rising exchange rate, whereas buying a put option can be used against the risk of a falling exchange rate. Options are traded on both the over-the-counter market and also on exchanges. In addition to use as a means to buy or sell currency, options can also used to buy or sell other derivatives such as futures.

Swap Contract.

A currency swap is an agreement between two parties to exchange flows of payments in two different currencies on different dates. Participants in currency swap agreements typically seek to exchange the terms of interest repayments available to the respective counter-parties to the agreement.

The payment flows are based on the exchange, or “swap,” of a defined amount known as the principal, or notional, amount. Often one party to the agreement will seek a fixed-rate interest payment at a steady yield while the other party seeks a floating-rate payment that could offer an opportunity for an improving yield.

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Derivatives Markets Definition and Examples.

Introduction to Derivatives.

Derivatives are tradable products that are based upon another market. This other market is known as the underlying market. Derivatives markets can be based upon almost any underlying market, including individual stocks (such as Apple Inc.), stock indexes (such as the S&P 500 stock index) and currency markets (such as the EUR/USD forex pair)

Types of Derivatives Markets.

There are several general derivatives markets, each containing thousands of individual derivatives which can be traded.

Here are the main ones day traders use:

Futures Markets Options Markets Contract For Difference (CFD) Markets.

Trading Derivatives Markets - Futures.

May day traders trade the futures market. This is because there are many different types of futures contracts to trade; many of them with significant volume and daily price fluctuations, which is how day traders make money. A futures contract is an agreement between a buyer to exchange money for the underlying, at some future date. For example, if you buy/sell a crude oil futures contract, you are agreeing to buy/sell a set amount of crude oil at a specific price (the price you place an order at) at some future date. You don't actually need to take delivery of the crude oil, rather you make or lose money based on whether the contract you bought/sold goes up or down in value relative to where you bought/sold it. You can then close out the trade at any time before it expires to lock in your profit or loss.

Trading Derivatives Markets - Options.

Options are another popular derivatives market. Options can be very complex or simple, depending on how you choose to trade them. The simplest way to trade options is through buying puts or calls.

When you buy a put you are expecting the price of the underlying to fall below the strike price of the option before the option expires.

If it does, you make money, if doesn't, then you will lose the value (or some of it) that you paid for the option. For example, if XYZ stock is trading at $63, but you believe it fall below $60, then you can buy a $60 put option. The put will cost you a specific dollar amount, called the premium. If the stock goes up, you only lose the premium you paid for the put. If the stock price goes down though then your option will increase in value, and you can sell it for more than what you paid for it (premium).

A call options works the same way, except when you buy a call you are expecting the price of the underlying to rise. For example, if you think ZYZY stock, currently trading at $58 will rally above $60, you can buy a call option with a strike price of $60. If the stock price rises, your option will increase in value and you stand to make more than you paid (premium). If the stock drops instead, you only lose the premium you paid for the call option.

Trading Derivatives Markets - Contract for Difference (CFD)

Contract for difference (CFD) markets are offered by various brokers, and therefore may differ from one broker to another. Typically they are simple instruments though, labeled with a similar name to the underlying.

For example, if you buy a crude oil CFD, you are not actually buying into an agreement to buy crude oil (like with a futures contract) rather you are just entering into an agreement with your broker that if the price goes up, you make money, and if the price goes down you lose money. A CFD is like a "side bet" on another market.

With most CFD markets (check with your broker), if you believe the underlying asset will rise, you buy the CFD. If you believe the underlying asset will decline in value, then you sell or short the CFD. Your profit or loss is the difference between the prices you enter and exit the trade at.

Final Word on Derivatives Markets.

Depending on a trader's trading style, and their capital requirements, one market may suit one trader more than another. Although one derivative market isn't necessarily better than another.

Each market requires different capital amounts to trade, base on the margin requirement of that market.

Futures are very popular with day traders--day traders only trade within the day and don't hold positions overnight. Options and CFDs are more popular among swing traders--swing traders take trades that last a couple days to a couple weeks.

Derivatives.

Definition.

Derivatives are financial instruments that acquires the majority of their value from the price of the underlying asset they are tracking such as commodities and currencies, or from securities such as stocks and bonds.

Swaps, futures, forwards, and options are the most common derivatives. Investors trade them on exchange or over-the-counter usually as an alternative to speculating in the underlying asset, or to hedge their risk on a position in the underlying asset.

A financial contract that depends on the commodity’s value and properties.

Related Terms.

Hedge funds are managed portfolios aimed to generate high returns by using aggressive investment.

If you’re looking for additional reading to supplement your forex trading education, you’ve come to the.

The Commodity Futures Trading Commission (CFTC) is a government agency established in 1974 to regulate the.

The National Futures Association (NFA) watches over the commodities and futures markets in the United.

Banking institutions cater to both the majority of commercial turnover and large amounts of speculative.

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