Derivatives

A derivative is a contract multiple parties enter into with a value that is determined by the price of an underlying asset. A derivative is a “lock” if it binds both parties to make a trade at some point in time. Forward contracts and futures contracts are both examples of lock products.

Conversely, a derivative is an “option” product if it gives the buyer of the contract the option but not the obligation to execute a trade at some point in time. An options contract is an example of an option product.

Derivatives are commonly used to increase a trader’s leverage or to hedge a position. Derivatives can be traded on secondary markets, but they tend to have significantly lower liquidity than their underlying assets.