A derivative is a financial instrument that is derived from some other asset, index, event, value or condition (known as the underlying asset). Rather than trade or exchange the underlying asset itself, derivative traders enter into an agreement to exchange cash or assets over time based on the underlying asset. A simple example is a futures contract an agreement to exchange the underlying asset at a future date.
Derivatives are often leveraged, such that a small movement in the underlying value can cause a large difference in the value of the derivative.
Derivatives can be used by investors to speculate and to make a profit if the value of the underlying moves the way they expect (e.g. moves in a given direction, stays in or out of a specified range, reaches a certain level). Alternatively, traders can use derivatives to hedge or mitigate risk in the underlying, by entering into a derivative contract whose value moves in the opposite direction to their underlying position and cancels part or all of it out.
