Equity derivative
Encyclopedia
In finance
, an equity derivative is a class of derivatives
whose value is at least partly derived from one or more underlying
equity
securities. Options
and futures are by far the most common equity derivatives, however there are many other types of equity derivatives that are actively traded.
, 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 lower 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.
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.
. 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.
These are used normally for correlation trading.
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 to speculation in the market....
(CFD) where one party gains exposure to a share price without buying or selling the underlying share
making it relatively cost efficient as well as making it relatively easy to transact.
s and Intellidex
es.
Finance
"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...
, an equity derivative is a class of derivatives
Derivative (finance)
A derivative instrument is a contract between two parties that specifies conditions—in particular, dates and the resulting values of the underlying variables—under which payments, or payoffs, are to be made between the parties.Under U.S...
whose value is at least partly derived from one or more underlying
Underlying
In finance, the underlying of a derivative is an asset, basket of assets, index, or even another derivative, such that the cash flows of the derivative depend on the value of this underlying...
equity
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
securities. Options
Option (finance)
In finance, an option is a derivative financial instrument that specifies a contract between two parties for a future transaction on an asset at a reference price. The buyer of the option gains the right, but not the obligation, to engage in that transaction, while the seller incurs the...
and futures are by far the most common equity derivatives, however there are many other types of equity derivatives that are actively traded.
Equity options
Equity options are the most common type equity derivative. They provide the right, but not the obligation, to buy (call) or sell (put) a quantity of stock (1 contract = 100 shares of stock), at a set price (strike price), within a certain period of time (prior to the expiration date).Warrants
In financeFinance
"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...
, a warrant is a security
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...
that entitles the holder to buy stock of the company that issued it at a specified price, which is much lower 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
Yield (finance)
In finance, the term yield describes the amount in cash that returns to the owners of a security. Normally it does not include the price variations, at the difference of the total return...
of the bond, and make them more attractive to potential buyers.
Convertible bonds
Convertible bonds are bonds that can be converted into shares of stockStock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
in the issuing company, usually at some pre-announced ratio. It is a hybrid security
Hybrid security
Hybrid securities are a broad group of securities that combine the elements of the two broader groups of securities, debt and equity.Hybrid securities pay a predictable rate of return or dividend until a certain date, at which point the holder has a number of options including converting the...
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.
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.Stock market index futures
Stock market index futures are futures contracts used to replicate the performance of an underlying stock market indexStock market index
A stock market index is a method of measuring a section of the stock market. Many indices are cited by news or financial services firms and are used as benchmarks, to measure the performance of portfolios such as mutual funds....
. 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
FTSE 100 Index
The FTSE 100 Index, also called FTSE 100, FTSE, or, informally, the footsie , is a share index of the 100 most highly capitalised UK companies listed on the London Stock Exchange....
, DAX
DAX
The DAX is a blue chip stock market index consisting of the 30 major German companies trading on the Frankfurt Stock Exchange. Prices are taken from the electronic Xetra trading system...
, CAC40 and other G12
Group of Twelve
The Group of Twelve or G12 is a group of industrially advanced countries whose central banks co-operate to regulate international finance....
country indices. Indices for OTC products are broadly similar, but offer more flexibility.
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, i.e. between established institutional investors), as the basket definition is not standardized in the way that an equity index is.These are used normally for correlation trading.
Single-stock futures
Single-stock futuresSingle-stock futures
Single-stock futuresIn finance, a single-stock futures is a type of futures contracts between two parties to exchange a specified number of stocks in company for a price agreed today with delivery occurring at a specified future date, the delivery date. The contracts are traded on a futures exchange...
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 to speculation in the market....
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 straightforward way of gaining exposure to an asset class you require. They can also be relatively cost efficient.Equity swap
An equity swap, like an equity index swap, is an agreement between two parties to swap two sets of cash flows. In this case the cash flows will be the price of an underlying stock value swapped, for instance, with LIBOR. A typical example of this type of derivative is the Contract for differenceContract for difference
In finance, a contract for difference is a contract between two parties, typically described as "buyer" and "seller", stipulating that the buyer will pay to the seller the difference between the current value of an asset and its value at contract time...
(CFD) where one party gains exposure to a share price without buying or selling the underlying share
Share (finance)
A joint stock company divides its capital into units of equal denomination. Each unit is called a share. These units are offered for sale to raise capital. This is termed as issuing shares. A person who buys share/shares of the company is called a shareholder, and by acquiring share or shares in...
making it relatively cost efficient as well as making it relatively easy to transact.
Exchange-traded derivatives
Other examples of equity derivative securities include exchange-traded fundExchange-traded fund
An exchange-traded fund is an investment fund traded on stock exchanges, much like stocks. An ETF holds assets such as stocks, commodities, or bonds, and trades close to its net asset value over the course of the trading day. Most ETFs track an index, such as the S&P 500 or MSCI EAFE...
s and Intellidex
Intellidex
An Intellidex is a securities product created by and proprietary to the American Stock Exchange. Intellidexes are created by analyzing groups of stocks and selecting specific stocks to include in an investment portfolio...
es.