Forward Contracts

Forward contracts are contracts for the futures sale of some commodity. The commodity may be a physical commodity, like pork bellies, or a financial commodity, like a currency. Forward contracts are very similar to futures contracts except they are not standardized and hence tend to be less liquid.

Futures Contracts

Standardized futures contracts are forward contracts that an exchange clearinghouse guarantees. Futures traders therefore do not care whether their counterparts are creditworthy. They only need to consider whether the clearinghouse is creditworthy. Moreover, since buyers and sellers trade the same contracts, and since the clearinghouse is a buyer to every seller and a seller to every buyer, traders can open a position by buying a contract from one trader and close the position by selling it to someone else. They do not need to buy and sell with the same trader to offset their positions.

Options

An option represents the right, but not the obligation, to do something. Option contracts give their holders the option to buy or sell an underlying instrument (or, in the case of a cash-settled option, the cash value of an underlying instrument) at a fixed price. The writer of the option is the trader who sold the contract. The option is written upon the underlying instrument. A call option is an option to buy at a fixed strike price. A put option is an option to sell at a fixed strike price. If the option holder can exercise the option any time before expiration date, it is an American-style option. If the holder can exercise only on the expiration date, it is a European-style option. Since option contracts depend on underlying security values, they are derivative contracts.

Futures Options

A futures option contract is an option contract written on a futures contract. The holder of a call option on a futures contract has the right to purchase a futures contract at a specified strike price. Likewise, the holder of a futures put option has the right to sell a futures contract at a specified strike price. Futures option contracts trade at the exchange where the underlying futures contracts trade.

Swaps

Swaps are contracts for the exchange of two future cash flows. A cash flow is a series of payments. An interest rate swap provides for the exchange of a future series of fixed-rate interest payments for a future series of variable floating rate interest payments. When they enter the contract, the traders negotiate the fixed-rate payments and agree upon a formula for computing the future variable-rate payments. A currency swap provides for the exchange of a future series of fixed payments in one currency for a future series of payments in another currency.