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Defining Financial Derivatives

Financial derivatives, commonly referred to as “derivatives,” are securities (or tradable instruments) whose value is determined by the price of other assets. Derivatives can be traded on an exchange or transacted over the counter, and may be used to access certain markets or hedge and reduce risk in a portfolio.

The Primary Types of Derivatives

Futures

Standardized contracts to buy or sell an asset at a given price and time.

Forwards

Customizable contracts to buy or sell an asset at a given price and time.

Options

Standardized contracts giving the right, but not the obligation, to buy (call option) or sell (put option) an asset at a given price and time.

Swaps

Customizable contracts to exchange the cash flows or liabilities from two different assets for a given period.

Hypothetical Options Trade

An investor is bullish on U.S. large-cap equities over the long term and is invested accordingly. However, they fear a short-term correction could be looming. To protect the value of the portfolio, the investor buys put options on an S&P 500 ETF. These put options provide the right, but not the obligation, to sell shares of the ETF at a predetermined level in the future. The value of the put options increases as the value of the S&P 500 decreases, which creates a hedge for the investor’s portfolio.

BENEFITS

icon-umbrella-coverage-v02Hedge or reduce short-term and/or unwanted portfolio exposures.

icon-diversificationDiversify current portfolio exposures.

icon-accessibilityCreate exposure to a different asset class for the potential to enhance returns.

KEY RISK CONSIDERATIONS

Key risk considerations may include, but are not limited to, the following:

icon-feesLoss of capital: The loss of capital may be greater than the amount initially invested.

icon-complex-transactionsComplex securities: Derivatives require specialized knowledge or expertise, given the complexity involved and the number of factors affecting a trade.

icon-counterparty-v03Counterparty risk: The probability that one party in a transaction defaults or does not fulfill their contractual obligation.

icon-strategyUnderlying assets and strategy: Each underlying asset and strategy will exhibit their own inherent risks.

Please contact your financial professional or wealth management platform to learn more.

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IMPORTANT INFORMATION

This material is provided for informational purposes only and is not intended as, and may not be relied on in any manner as legal, tax or investment advice, a recommendation, or as an offer to sell, a solicitation of an offer to purchase or a recommendation of any interest in any fund or security offered by Institutional Capital Network, Inc., or its affiliates (together “iCapital”).

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