Type - Equity
Equity derivatives can be exchange traded or OTC
With exchange traded equity derivatives most of the transactions are either Futures or Options.
OTC Equity Swaps are also an important part of this market.
The global equity market can at times be very tight and illiquid this is because equities are split into different countries and sectors. How many market makers are there in an individual share, in a particular country.
When trading equity derivatives there are two aspects you need to consider:
1) movement of the individual share
2) movement of the market as a whole
A porfolio manager will hold a number of different stocks and will generally be more concerned about the performance of them as a whole rather than individually.
To counteract the effect of a single share performing badly, the portfolio manager will need to hold a diversified porfolio of stocks that are unrelated.
If one stock goes down another may go up.
Generally about 60% of the risk that affects individual shares relative to the index can be eliminated by holding 10 uncorrelated stocks.
All but 10% of the risk that affects individual shares relative to the index can be eliminated by holding 20 uncorrelated stocks.
They are frequently attached to bonds or preferred stock meaning the issuer can pay a smaller coupon or a smaller dividend.
They can be used to enhance the yield of the bond and make them more attractive to potential buyers.
These are exchange traded
Their performance is similar to that of the underlying stock
They are usually traded with higher leverage
They can be cash settled or physically settled at expiry
In the US only physical settlement is allowed to avoid speculation.
or equity options are the most common type of equity derivative
These are futures that replicate the performance of an underlying index.
They can be used to hedge against an existing stock position or to speculate on the movement of the index.
There are futures on a lot of the well established indices: S&P, FTSE, DAX, CAC40 etc
Stock Basket Futures
Stock Basket Options
Stock Basket Swaps
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