What is a derivative & how does it work?

The term derivative refers to a type of financial contract whose value is dependent on an underlying asset, group of assets, or benchmark. A derivative is set between two or more parties that can trade on an exchange or over-the-counter (OTC). These contracts can be used to trade any number of assets and carry their own risks.

What is a collar option?

What Is a Collar? A collar, also known as a hedge wrapper or risk-reversal, is an options strategy implemented to protect against large losses, but it also limits large gains. An investor who is already long the underlying creates a collar by buying an out-of-the-money put option while simultaneously writing an out-of-the-money call option.

Why do speculators use derivatives?

Since using derivatives, especially options, is an inexpensive and highly liquid way to gain exposure to an asset without necessarily owning that asset, derivatives are a very important part of the arsenal for financial market speculators.

What are the underlying assets for derivatives?

The most common underlying assets for derivatives are stocks, bonds, commodities, currencies, interest rates, and market indexes. Contract values depend on changes in the prices of the underlying asset. Derivatives can be used to hedge a position, speculate on the directional movement of an underlying asset, or give leverage to holdings.