1. INTRODUCTION TO DERIVATIVES ........... 4

1.1 Basics of derivatives ........................... 5

1.2 Types of Derivatives ........................... 6

1.3 History of Derivatives Markets .............. 6

1.4 The Markets ....................................... 7

1.5 Types of Market Participants in Derivatives Markets ..............8

1.5.1 Hedgers ...................................................................... 8

1.5.2 Speculators ................................................................. 9

1.5.3 Swap Dealers and Commodity Index Traders ...................................................................... 10

2. FORWARDS AND FUTURES ......................................... 12

2.1 Forward Contracts ................................................... 12

2.2 Futures .................................................................. 14

2.2.1 Contract Specifications .............................. 15

Box 1: Grade and Quality Specifications of WTI Contract ........................................................... 16

2.2.2 The Clearinghouse Margins .......................... 17

2.2.3 Settlement Price, Volume and Open Interest in Futures Markets ....... 19

2.2.4 Types of Orders ......................................................... 20

2.3 Hedging Using Futures Contracts ..................................... 20

2.4 Basis Risk ..................................................................... 22

3. SWAPS ........................................................................... 23

3.1 Mechanics of Swaps ........................................................ 26

4. OPTIONS ......................................................................... 28

4.1 Call Option ..................................................................... 29

4.2 Put Option ...................................................................... 32

4.3 “Moneyness” of Options ............................................... 33

4.4 Hedging Using Options ................................................. 34

5. REFERENCES ..................................................... 35