Sunday, June 24, 2012

Participants of Derivatives Market

Derivative contracts are of different types. The most common ones are forwards, futures, options
and swaps. Participants who trade in the derivatives market can be classified  under the following
three broad categories – hedgers, speculators, and arbitragers.
1. Hedgers: The farmer's example that we discussed about was a case of hedging. Hedgers face risk
associated with the price of an asset. They use the futures or options markets to reduce or eliminate
this risk.
2. Speculators: Speculators are participants who wish to bet on future movements in the price of an
asset. Futures and options contracts can give them leverage; that is, by putting in small amounts of
money upfront, they can take large positions on the market. As a result of this leveraged speculative
position, they increase the potential for large gains as well as large losses.

3. Arbitragers: Arbitragers work at making pro ts by taking advantage of discrepancy between prices
of the same product across different markets. If, for example, they see the futures price of an asset
getting out of line with the cash price, they would take offsetting positions in the two markets to lock
in the pro t.
Whether the underlying asset is a commodity or a financial asset, derivative markets performs
a number of economic functions.
 Prices in an organized derivatives market reflect  the perception of market participants about the future
and lead the prices of underlying to the perceived future level. The prices of derivatives converge
with the prices of the underlying at the expiration of the derivative contract. Thus derivatives help in
discovery of future as well as current prices.
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