The derivatives family

An option is a derivative — its value derives from something else. But it’s only one member of a much bigger family. Knowing the neighbours sharpens your understanding of what makes options special.

The key dividing line: right vs obligation

• An option gives you the right, not the obligation, to transact. You can walk away; the most you lose is the premium.
• A future, forward, or swap is an obligation. Both sides are committed to transact, so the payoff is linear — no “walk away” floor.

That asymmetry — capped downside on a long option, an obligation on the others — is the whole reason options behave so differently.

Forwards

A forward is a private agreement to buy or sell an asset at a set price on a future date.

• Customised (any size, any date, any terms).
• Traded over-the-counter (directly between two parties), so it carries counterparty risk — the other side might not pay up.
• No money changes hands until settlement.

Futures

A future is a forward’s standardised, exchange-traded cousin.

• Standard sizes and dates, traded on an exchange.
• A clearinghouse sits in the middle, so counterparty risk is largely removed.
• Marked to market daily — gains and losses settle every day via margin, rather than all at once at expiry.

Futures are the workhorse for hedging commodities, indices, and rates.

Swaps

A swap is an agreement to exchange cash flows over time. The classic example is an interest-rate swap: one party pays a fixed rate, the other pays a floating rate, on the same notional amount.

• Used to transform exposure — e.g. a company with a floating-rate loan swaps into fixed to lock in its costs.
• Over-the-counter, customised, and typically used by institutions.

Where options fit

That bent payoff is the magic of options — it’s what lets you shape risk, cap losses, and express nuanced views on direction, time, and volatility. The other derivatives are powerful, but they can’t bend. That’s why everything else in this course is about options.