Derivatives and Structured Products
Building blocks
Forwards and futures fix a price today for future delivery; futures are standardised, exchange-traded, margined and marked to market daily, with a clearing house using novation to remove counterparty risk. Options confer rights, not obligations: the buyer pays a premium, the writer carries the obligation. Swaps exchange cash-flow streams - interest rate, currency, equity or credit.
Payoffs and risk
Greeks are delta, gamma, theta, vega and rho. Structured products combine a bond with derivatives, for example an equity-linked note (principal plus call option) or an autocallable with knock-in barrier. Stress the barrier scenarios, not just the base case.
Worked example
An investor buys a stock at $50 and a $45 put for $2. Breakeven is $52; maximum loss is $7 (the $5 fall to the strike plus the $2 premium); upside above $52 is unlimited. This is a protective put - insurance with a known cost.
Traps
Confusing the writer's risk (potentially unlimited on calls) with the buyer's capped loss; treating futures margin as a cost rather than collateral; and assuming a barrier product's headline coupon represents expected return.