In finance, an equity derivative is a class of financial instruments whose value is at least partly derived from one or more underlying equity securities. Market participants trade equity derivatives in order to transfer or transform certain risks associated with the underlying security. Options are by far the most common equity derivative, however there are many other types of equity derivatives that are actively traded.

Equity options

Equity options are the most common type of equity derivative. They provide the right, but not the obligation to trade a quantity of stock at a set price at a future time.

Warrants

Convertible bonds

Convertible bonds are bonds that can be converted into shares of stock in the issuing company, usually at some pre-announced ratio. It is a hybrid security with debt- and equity-like features. It can be used by investors to obtain the upside of equity-like returns while protecting the downside with regular bond-like coupons.

Equity futures, options and swaps

Stock market index futures are futures contracts used to replicate the performance of an underlying stock market index. They can be used for hedging against an existing equity position, or speculating on future movements of the index. Indices for futures include well-established indices such as S&P, FTSE, DAX, CAC40 and other G12 country indices. Indices for OTC products are broadly similar, but offer more flexibility.

Equity basket derivatives

Equity basket derivatives are futures, options or swaps where the underlying is a non-index basket of shares. They have similar characteristics to equity index derivatives, but are always traded OTC, as the basket definition is not standardised in the way that an equity index is.

Single-stock futures

Single-stock futures are exchange-traded futures contracts based on an individual underlying security rather than a stock index. Their performance is similar to that of the underlying equity itself, although as futures contracts they are usually traded with greater leverage. Another difference is that holders of long positions in single stock futures typically do not receive dividends and holders of short positions do not pay dividends. Single-stock futures may be cash-settled or physically settled by the transfer of the underlying stocks at expiration, although in the United States only physical settlement is used.

Equity index swaps

An equity index swap is an agreement between two parties to swap two sets of cash flows on predetermined dates for an agreed number of years. The cash flows will be an equity index value swapped, for instance, with LIBOR. Swaps can be considered as being a relatively straight forward way of gaining exposure to an asset class you require. They can also be relatively cost efficient.