Derivatives 101

Derivatives are contracts that derive their value from the performance of an underlying asset. Traders use derivatives to access specific markets and trade different assets. Typically, derivatives are considered a form of sophisticated investing. The most common underlying assets for derivatives are stocks, bonds, commodities, currencies, interest rates, and market indexes. Contract values depend on changes in the prices of the underlying asset.

These contracts can be used to trade any number of assets and carry their own risks. Derivatives can be used to either mitigate risk (hedging) or assume risk with the expectation of commensurate reward (speculation). They can move risk (and the accompanying rewards) from the risk-averse to the risk seekers. Derivatives have numerous uses and various levels of risks but are generally considered a sound way to participate in the financial markets.