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Definition of 'Equity Derivative'
A derivative instrument with underlying assets based on equity securities. An equity derivative's value will fluctuate with changes in its underlying asset's equity, which is usually measured by share price.
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Investopedia explains 'Equity Derivative'
Investors can use equity derivatives to hedge the risk associated with taking a position in stock by setting limits to the losses incurred by either a short or long position in a company's shares. The investor receives this insurance by paying the cost of the derivative contract, which is referred to as a premium. If an investor purchases a stock, he or she can protect against a loss in share value by purchasing a put option. On the other hand, if the investor has shorted shares, he or she can hedge against a gain in share price by purchasing a call option.
Options are the most common equity derivatives because they directly grant the holder the right to buy or sell equity at a predetermined value. More complex equity derivatives include equity index swaps, convertible bonds or stock index futures.
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These derivatives allow investors to transfer risk, but there are many choices and factors that investors must weigh before buying in.
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Learn how to multiply returns and diversify risk by buying options instead of stock.
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These contracts allow for easier shorting, and provide more leverage and flexibility than stocks.
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