Equity derivative
From Wikipedia, the free encyclopedia
In finance, an equity derivative is a class of financial instruments whose value is at least partly derived from one or more underlying equity securities. Market participants trade equity derivatives in order to transfer or transform certain risks associated with the underlying security. Options are by far the most common equity derivative, however there are many other types of equity derivatives that are actively traded.
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[edit] Equity options
Equity options are the most common type of equity derivative.[1] They provide the right, but not the obligation to trade a quantity of stock at a set price at a future time.
[edit] Warrants
In finance, a warrant is a security that entitles the holder to buy stock of the company that issued it at a specified price, which is much higher than the stock price at time of issue. Warrants are frequently attached to bonds or preferred stock as a sweetener, allowing the issuer to pay lower interest rates or dividends. They can be used to enhance the yield of the bond, and make them more attractive to potential buyers.
[edit] Convertible bonds
Convertible bonds are bonds that can be converted into shares of stock in the issuing company, usually at some pre-announced ratio. It is a hybrid security with debt- and equity-like features. It can be used by investors to obtain the upside of equity-like returns while protecting the downside with regular bond-like coupons.
[edit] Equity futures, options and swaps
Investors can gain exposure to the equity markets using futures, options and swaps. These can be done on single stocks, a customized basket of stocks or on an index of stocks. These equity derivatives derive their value from the price of the underlying stock or stocks.
[edit] Stock market index futures
Stock market index futures are futures contracts used to replicate the performance of an underlying stock market index. They can be used for hedging against an existing equity position, or speculating on future movements of the index. Indices for futures include well-established indices such as S&P, FTSE, DAX, CAC40 and other G12 country indices. Indices for OTC products are broadly similar, but offer more flexibility.[vague]
[edit] Equity basket derivatives
Equity basket derivatives are futures, options or swaps where the underlying is a non-index basket of shares. They have similar characteristics to equity index derivatives, but are always traded OTC (over the counter, ie between established institutional investors),[dubious ] as the basket definition is not standardised in the way that an equity index is.
[edit] Single-stock futures
Single-stock futures are exchange-traded futures contracts based on an individual underlying security rather than a stock index. Their performance is similar to that of the underlying equity itself, although as futures contracts they are usually traded with greater leverage. Another difference is that holders of long positions in single stock futures typically do not receive dividends and holders of short positions do not pay dividends. Single-stock futures may be cash-settled or physically settled by the transfer of the underlying stocks at expiration, although in the United States only physical settlement is used.
[edit] Equity index swaps
An equity index swap is an agreement between two parties to swap two sets of cash flows on predetermined dates for an agreed number of years. The cash flows will be an equity index value swapped, for instance, with LIBOR. Swaps can be considered as being a relatively straight forward way of gaining exposure to an asset class you require. They can also be relatively cost efficient.
[edit] Exchange-traded derivatives
Other examples of equity derivative securities include exchange-traded funds and Intellidexes.
[edit] References
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