Derivatives are financial products designed around existing assets — for example, Bitcoin futures or Bitcoin options are derivatives of Bitcoin. The market for these products is called the derivatives market.
There are two popular types of derivatives markets: OTC markets and exchange-traded markets.
OTC derivatives are contracts not traded on standardized exchanges, but rather over the counter. Hence, OTC derivatives can often be customized to fit both parties’ requirements.
Exchange-traded derivatives trade on exchanges. They have high liquidity, standardization, and risk hedging advantages.
Understanding the Types of Derivatives
Derivatives are financial instruments that derive their value from an underlying asset. An underlying asset in the case of crypto could be the individual asset like bitcoin or Ethereum. Currently, there are several types of Derivative contracts proving unique in their ways. Among them include;
- Futures. Futures contracts are where a party agrees to buy assets at a predetermined price and specified future date.
- Forwards. A forward is a non-standardized agreement between parties to trade assets at a preset price and future date. Forwards help to hedge against market risks.
- Options. An option is a contract whose owners have the right to buy or sell the underlying instrument on or before a specified date. Options have a specific strike price.
- Swaps. Swaps are agreements between two parties where they exchange financial obligations. Swaps are among the OTC derivatives.
Participants in Derivative Markets
There are several participants in a derivative market that make the markets thrive. Among them include;
- Hedgers. Hedgers are persons who invest but aim to reduce their price volatility risks. They are common in markets, especially since derivatives are good for hedging.
- Speculators. A speculator is an individual who invests in an asset with speculations of future price increases. Often, speculators’ main goal is earning huge profits. But, speculation is quite risky in markets.
- Arbitrageurs. These are traders who focus on profiting from the market price volatilities. In the case of cryptos volatilities, arbitrageurs can earn.
- Margin traders. Margin traders are people who invest in financial instruments on credit. They put up collateral that helps cover the credit risk connected to this investment.