In finance, an equity derivative is a class of financial instruments whose value is at least partly derived from one or more underlying equity securities. Market participants trade equity derivatives in order to transfer or transform certain risks associated with the underlying security. Options are by far the most common equity derivative, however there are many other types of equity derivatives that are actively traded.

Equity options

Equity options are the most common type of 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 finance, 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 higher 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.

Convertible bonds

Convertible bonds are bonds that can be converted into shares of stock 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.

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 index. 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.

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, ie 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 futures 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 avoid 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 difference (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 relevantly easy to transact.

Exchange-traded derivatives

Other examples of equity derivative securities include exchange-traded funds and Intellidexes.

Equity derivative Topic - Derivatives

A derivative is a financial instrument that is derived from some other asset, index, event, value or condition (known as the underlying asset). Rather than trade or exchange the underlying asset itself, derivative traders enter into an agreement to exchange cash or assets over time based on the underlying asset. A simple example is a futures contract: an agreement to exchange the underlying asset at a future date.