Derivative
A derivative is a financial contract whose value is based on, or derived from, the price of an underlying asset such as a stock, bond, commodity, index or currency.
The main types of derivatives are options, futures, forwards and swaps. Options give a right to buy or sell; futures and forwards create an obligation to trade at a set price in the future; swaps exchange streams of payments, such as fixed for floating interest rates.
Some derivatives trade on regulated exchanges with standardized terms and a central clearinghouse. Others are traded over the counter (OTC), negotiated directly between parties, which can add counterparty risk, the danger that the other side fails to pay.
Derivatives serve two broad purposes. Hedgers use them to reduce risk, such as a farmer locking in a crop price or a fund protecting a stock portfolio. Speculators use them to bet on price moves with less capital up front.
Because many derivatives involve leverage, small price changes can produce large gains or losses. Example: a 5% move in an index can translate into a 50% or larger move in some options on that index.