Derivative
TradingDefinition
A financial contract whose value is tied to (derived from) the price of something else, like a stock, a commodity, a currency, or an interest rate. The four main types: futures, forwards, options, and swaps. Derivatives have three main uses: hedging (farmers locking in grain prices months in advance), speculating (making leveraged bets), and arbitrage (exploiting tiny pricing mismatches).
The global notional value of derivatives is over $700 trillion, many times the size of the real economy. When used for hedging they make the system more stable. When used to stack leverage they have been at the center of major crises (2008 credit default swaps, 1998 LTCM blowup).
The global notional value of derivatives is over $700 trillion, many times the size of the real economy. When used for hedging they make the system more stable. When used to stack leverage they have been at the center of major crises (2008 credit default swaps, 1998 LTCM blowup).
Example
An airline worried about fuel prices buys jet-fuel futures that lock in next year's cost. That is pure hedging. A hedge fund selling naked call options on the S&P 500 index is pure speculation, with unlimited potential loss.