Derivatives are financial contracts that derive their value from an underlying asset, which can either be a financial asset or a commodity. In over-the-counter (OTC) markets, where contracts can be customized and specifically designed to meet investor needs, the underlying asset options are nearly limitless.
Commodity futures and options are often used by producers, merchandisers, and processors of commodities to protect themselves against fluctuating prices.
The most widely optioned commodities include:
- Grains and oilseeds
- Livestock and meat
- Forest, fibre, and food
- Precious and industrial metals
- Energy products
With the exception of energy products, commodity futures are exchange-traded.
The most common financial derivatives are options and futures tied to equities, interest rates, and currencies.
Equity derivatives are the largest category of financial derivatives, consisting primarily of equity options that trade on organized exchanges.
Its namesake may be misleading, as interest rate derivatives are not traded on the interest rate directly, but rather on securities that are interest-rate sensitive, such as banker’s acceptances (BAs) and government bonds. In Canada, all interest rate futures trading takes place on the Montreal Exchange. In the OTC market, interest rate derivatives are generally based on well-defined and well-known floating interest rates, such as yields on T-bills and Treasury bonds. Since these OTC derivatives are based on interest rates, rather than an actual security, physical delivery is not possible and all contracts must be settled in cash.
Currency futures and options are traded on organized exchanges. Currency forwards and currency swaps are traded in the OTC markets. The most popular currency derivative contracts are quoted in U.S. dollars, British pounds, Japanese yen, Swiss francs, and euros.