The most common types of derivatives include futures contracts, forward contracts, options, and swaps. Below you will find a brief breakdown of each one.
Futures contracts exist between two parties who agree to purchase and deliver an asset at a specific price at a future date. Futures contracts are standardized and traded on exchanges. Both parties involved are obligated to fulfill a commitment to buying or selling the underlying asset.
Forward contracts are similar to futures, but they are not exchange-traded. Instead, forwards are traded over-the-counter (OTC), meaning this occurs within a dealer network rather than an exchange. When creating a forward contract, both parties customize the terms, size, and settlement process for the derivative. As OTC products, forward contracts carry a greater degree of counterparty risk for both buyers and sellers.
Swaps are commonly used to exchange currencies. For example, a trader might use an interest rate swap to switch from a variable interest rate loan to a fixed interest rate loan, or vice versa. In the crypto space, perpetual swaps are used for trading in two different cryptocurrencies.
Options contracts are similar to futures contracts, and are generally referred to as “options”. The key difference between options and futures is that the buyer is not obligated to exercise their agreement to buy or sell with an option. Options present an opportunity only, whereas futures are obligations.