What is a derivative contract?

Derivative contracts are arrangements between two entities — often referred to as a "counterparty" — that work together to reduce risk on their overall investment and the underlying asset. Derivatives can also be used as a leveraging tool.

How do derivatives work?

Derivatives can be used to hedge a position, speculate on the directional movement of an underlying asset, or give leverage to holdings. These assets are commonly traded on exchanges or OTC and are purchased through brokerages.

What are the different types of derivatives?

Derivatives are usually leveraged instruments, which increases their potential risks and rewards. Common derivatives include futures contracts, forwards, options, and swaps. A derivative is a complex type of financial security that is set between two or more parties. Traders use derivatives to access specific markets and trade different assets.

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.