A derivative is a financial contract whose value depends on (or derives from) the values of other basis variables such as stock prices, bond values, interest rates, exchange rates, commodity prices, market indices, etc. Such basis variables are called underlyings. There are three broad categories of traders interested in trading derivatives contracts:
hedgers who use derivatives to reduce the risk that they face from potential future movements in market variables;
speculators who use derivatives to bet on the future directions of market variables;
arbitrageurs who take offsetting positions in two or more instruments to lock in a risk-free profit.
In this chapter we consider two main derivative contracts, ...