A derivative is a security in which the price of securities is dependent on one or more underlying assets. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indices.
Some types of derivatives can be used to hedge or insurance against the risk of the asset. Derivatives can also be used for speculation to bet on the future price of an asset, or to find a way in matters of the exchange rate.
To open a long or short position in derivative
A derivative is a contractual agreement usually between two parties. One side short the derivative, while the other party have long been derived. When a participant buys a derivative security, it is considered a long derivative. When the short side derivative, is the seller of the derivative.
One type of derivative, a security is stock options. One option contract on a stock gives the buyer or holder of the option the right to buy or sell the underlying commodity at a specific price on or before the date of expiry of the option. Traders and investors could be long call or put option and just as they can be short a call or put option.
For example, suppose a trader is long a call option on stock ABC. A trader bullish on the stock and believes the share price will rise. Thus, the trader has the right to buy the underlying asset. Holding the long call win trader positive if the stock price of ABC exceeds a predetermined price the strike more than the premium paid for the option.
Conversely, suppose that a trader believes that the price of ABC stock will decrease and the result sells (or writes) a call. Because the option was sold, long holder of a call controls whether this feature will be implemented. The seller of a call is obligated to deliver shares in a long-term holder of the call if the option is implemented.
Payments to the seller of the option is equal to premiums received from the option buyer if the stock price falls below the strike price. However, if the stock rises more than the exercise price plus the premium, the writer loses the money.