Derivatives are contracts that specify the right to buy, sell, or swap the underlying asset. The most common underlying assets for derivatives are securities, currencies, interest rates, profitability, derivatives, commodities, market indexes, etc.

The relevant executive authority determines the order of derivatives’ settlement and circulation through the stock exchange.

According to Azerbaijani legislation (the Civil Code), common derivatives include futures, forwards, options and swaps.

A futures contract is an agreement between two parties for the purchase and delivery of an asset at an agreed price at a future date. The underlying assets of the futures are wheat, precious and non-ferrous metals, oil and oil products. Futures are traded on the stock exchange. In order to reduce the trading risk, traders participating in futures trading are required to deposit a margin of 5% to 15% of the total contract value.

An option contract is an agreement between two parties to buy, sell or swap an asset. Unlike futures, with an option, the buyer is not obliged to exercise their agreement to buy or sell. There are following types of options:

  • Call option - is an agreement that gives the option buyer the right to buy the underlying asset at a specified price within a specific time period;
  • Put option - gives owners the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified timeframe;
  • A swaption (swap option) - refers to an option to enter into a swap agreement with another party.

A swap is a derivative contract through which two parties exchange one kind of cash flows or liabilities. There are different types of swap: interest rate swap, currency swap, etc.

  • Interest rate swap is a contract on exchanging one stream of future interest payments for another, based on a specified principal amount between two counterparties. Usually, interest rate swaps can be fixed or floating rate. The main objective of companies using interest rate swaps is to protect themselves from the risks of fluctuations in interest rate.
  • Currency swap is contract between two parties to exchange two currencies later, but at a predetermined exchange rate.

Derivatives are used to hedge or speculate on the price of the underlying asset. The speculators try to make a profit from the price change of the assets, indexes and financial instruments.