Equity derivative

An equity derivative is a derivative contract that references the performance of one or more equities, or equity indices. Where more than one Share or Index is referenced, the technical term is a Basket.

It is most usually documented under the 2002 ISDA Equity Derivatives Definitions, and the place you should immediately visit is the Equity Derivatives Anatomy.

Types of equity derivative

• Equity swap contracts, which are generally total return swaps and related index swap contracts
• Option contracts
• Forward contracts

Features

Equity derivatives generally reference the performance of the underlier over the life of the transaction, most commonly represented as a fraction whereby Settlement Price (also known as "Final Price") is divided by "Strike Price" (also known as "Initial Price") to yield a percentage - anything greater than 100% implies a positive return over the life of the transaction; a figure of less than 100% implies a negative return.

• Strike Price: generally the price of the underlier at the inception of the trade
• Settlement Price: generally the price of the underlier at the scheduled maturity of the trade
• Barriers: above or below which the trade may knock in, knock out, or the settlement formula may adjust;
• Valuation: on the Settlement Date, the settlement Price will be determined by reference to one or more Valuation dates, (if more than one Averaging may be applied)

Market and Hedging disruption

• Market Disruption: Contingency plans need to be made for what to do where it is not possible to make a valuation on any day on which one might be required (these may occur periodically through the transaction, and may be daily).
• Hedging Disruption: where the market is finctioning, but for some reason there are impediments to efficiently or legally hedging an exposure under an equity derivative.