Different Types Of Derivatives – A Beginner’s Guide

By Author: Charli
Total Articles: 8
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 Derivatives are contracts whose value is based on the underlying asset. However, not all of them operate in the same manner since there are different types of derivatives. As of April 2025, India accounted for over 60% of the 7.3 billion worldwide stock derivative trading volumes. Despite this fact, most Indians are not aware of what derivatives are.
This blog provides a simple guide to understanding the different types of derivatives and explains them with appropriate examples.
What are Derivatives?
Derivatives are financial contracts that are determined by the value of underlying assets. These assets are stocks, bonds, currencies, commodities, and market indexes. The value of these assets varies based on market conditions.
The main purpose of trading derivative contracts is to earn profit by betting on the future price of the underlying asset, considering the potential for its price fluctuations.
Types of Derivatives
There are 4 types of derivatives you can trade, which are described ...
... below:
 

Forward Contract

 
Forwards are private agreements for buying or selling assets at a predetermined price. However, they carry high counterparty risk due to the lack of a clearinghouse. For companies with specialised requirements, like exporters protecting themselves from currency swings, forward contracts are especially beneficial.
 

Futures Contract

 
Futures are essentially the same financial contracts as forwards. However, the primary difference between them is that futures are traded on an exchange and forwards are traded privately.
 

Options Contract

 
If you are wondering what is options trading, it is a type of trading in which the holder has the right, but not the obligation, to purchase or sell an asset on a given date at a predefined price. There are 2 types of options: a call option and a put option.

Call options give the buyer the option to buy the underlying asset at a predetermined price, also known as the strike price. Investors who expect the price of the asset to rise frequently use call options.
With put options, the buyer can sell the underlying asset at a predetermined price. Using a put option, they can hedge against a possible drop in the asset’s price.

Swaps

 
As the name suggests, swaps are just what they sound like. It is used to change one kind of cash flow into another. These private agreements between parties are mostly transacted over the counter rather than on stock exchanges.
Understanding Forward Contracts With an Example
You want to sell lentils at the current price of INR 30 per kg, but you think that after a month, some factors might drop the price. You decide to enter into a forward contract with a grocery shop as a result.
After a month, you will sell lentils for INR 30. If the price of the lentils falls below INR 30, you will not lose any money. Even if the prices rise, you will only receive the agreed-upon price of INR 30 per kg.
Understanding Futures Contracts With an Example
You and a grocery shop are two different parties, where you produce wheat and the shop frequently needs it.
You both agree on a fixed price of INR 40 per kg for the wheat after 30 days, and the shop agrees to exchange 50 kg of wheat. 
After 30 days, the profitability scenarios will be:

The shop will profit INR 5 per kg if the market price rises to INR 45 per kg because it has purchased the product below the current rate. 
You will profit INR 5 per kg if the price drops to INR 35 per kg.

Understanding Options Contracts With an Example
You think that company X’s share price will increase in the upcoming month, which is now trading at INR 100. You choose to purchase a call option with a one-month expiration date and a strike price of INR 120. For this call option, you have paid INR 5 as premium.

Scenario 1: If the stock price hits INR 130 before the expiration date, you can exercise your call option and buy it at INR 120. Your earnings will be:

Current price of stock – strike price – premium
INR (130 – 120 – 5) per share = INR 5 per share

Scenario 2: If the price does not hit INR 120 and remains at INR 115. You can choose not to exercise the contract and let it expire. You will lose only the premium of INR 5.

This procedure will be the same when selling stocks with call and put options.
Understanding Swaps With an Example
Consider that Company X has a loan with a fixed interest rate of 5% and Company Y has a loan with a variable interest rate that is currently at 4%. While Y wants stability, X wants a decline in interest rates. Hence, they sign an agreement to exchange interest rates.
If the variable rate falls to 3% after the swap:

Company X will pay less in interest
By paying a constant 5% rate independent of market movements, Company Y can achieve stability.

Both businesses can use this exchange to control interest rate risks under their financial plans.
Final Thought
In contemporary finance, derivatives are essential because they provide chances for investment, speculation, and risk management. You can make a profit by understanding the different types of derivative contracts.
Using these derivatives like forwards, futures, options, and swaps, you can predict price swings and increase your margin for profits.