What is a derivative contract?

The name “derivative” comes from the fact that the contract derives its value from the underlying asset. Since the value of the assets changes over time, so does the value of a derivative contract from an investment standpoint. As with any form of investment, derivatives come with their own benefits and drawbacks.

What is an example of a derivative?

One example of a derivative is a stock option because the value is "derived" from the underlying stock. Although assets determine a derivative's value, owning the derivative doesn't equate to owning the asset. Futures contracts are derivatives because their value is affected by the underlying contract's performance.

Are derivatives a form of advanced investing?

Typically, derivatives are considered a form of advanced investing. The most common underlying assets for derivatives are stocks, bonds, commodities, currencies, interest rates, and market indexes.

Why are derivatives used as an insurance policy?

Derivatives are used as an insurance policy to reduce risk and it generally is used with the objective of minimizing risk in the market. It is clear from the above example that the corn farmer and the buyer derivatives were used to hedge price risk by locking in the price of corn.