Different types of derivatives have different pricing mechanisms. A derivative is a financial contract with a value based on an underlying asset. The most common derivative types are futures contracts, forward contracts, options and swaps. More exotic derivatives can be based on factors such as weather or carbon emissions.
Futures contracts are financial contracts to buy or sell an underlying commodity at a certain price in the future. Therefore, the futures contract's value is based on the commodity's cash price. For example, consider a corn futures contract that represents 5,000 bushels of corn. If corn is trading at $5 per bushel, the value of the contract is $25,000. Futures contracts are standardized to include a certain amount and quality of the underlying commodity, so they can be traded on a centralized exchange. The futures price moves in relation to the spot price for the commodity based on supply and demand for that commodity.
Options on stocks and exchange-traded funds are also common derivative contracts. Options give the buyer the right, as opposed to the obligation, to buy or sell 100 shares of a stock at a strike price for a predetermined amount of time.
The best-known pricing model for options is the Black-Scholes method. This method considers the underlying stock price, option strike price, time until the option expires, underlying stock volatility and risk-free interest rate to provide a value for the option.