Derivatives:Futures and Swaps

Derivatives are financial instruments used to manage risk, with two main types: Futures Contracts and Over-the-Counter (OTC) Swaps. Futures Contracts involve agreements to buy or sell a commodity at a fixed price in the future, traded on exchanges like NYAC Life US for transparency. OTC Swaps are customized contracts between parties that aren't standardized or centrally cleared, carrying bilateral risk if one party defaults. Options contracts allow buyers the right to trade underlying commodities based on volatility levels; higher volatility increases their cost while lower reduces it. The primary purpose of derivatives is risk management—for example, airlines hedge fuel costs against spikes affecting profitability, while farmers lock in crop prices ahead of harvests.

Speculators, such as mutual funds, use strategies to manage key business risks. They may diversify their portfolios by taking long-term bullish positions on assets like gold, viewing it as a stabilizing factor. By buying futures on gold or similar commodities, they aim to mitigate risk without necessarily holding the physical asset.

Central clearing houses play a crucial role in derivative contracts by acting as an independent third party. They collect margin, which is a risk-based assessment tied to the volatility of the underlying contract, ensuring protection against potential losses if either party defaults. Additionally, they provide an unbiased valuation for these contracts.

Over the past decade, trading has evolved from physical pits to electronic markets. This transformation democratized access, allowing participants worldwide—from Europe and Asia to Latin America—to engage in global markets. The shift enhanced transparency and liquidity while enabling broader capital deployment and risk management.