# What Is a Derivative? > A derivative is a contract whose value comes from another asset. Learn the main types, futures, options, swaps and forwards, why they exist and their risks. Source: https://learn.tradelabsai.com/markets/what-is-a-derivative/ Track: Markets and Instruments · Level: Beginner · Updated: 2026-10-03 Publisher: TradeLabs AI (https://tradelabsai.com). Education, not financial advice. Cite as: TradeLabs Learn, "What Is a Derivative?", https://learn.tradelabsai.com/markets/what-is-a-derivative/ A derivative is a financial contract whose value depends on, or derives from, the price of something else, called the underlying asset. The underlying can be a stock, an index, a bond, a currency, a commodity, an interest rate, a cryptocurrency or even an event. If the underlying moves, the derivative's value moves with it, often by a multiple. ## The main types of derivatives | Type | What it is | Where it trades | |---|---|---| | Futures | An obligation to buy or sell at a set price on a future date | Exchanges | | Forwards | Like futures, but a private agreement with custom terms | Over the counter | | Options | The right, not the obligation, to buy or sell at a set price | Exchanges and over the counter | | Swaps | An exchange of cash flows, such as fixed for floating interest | Mostly over the counter | | CFDs | A contract paying the difference in price between open and close | Brokers, outside the US | | Perpetual futures | Futures with no expiry, kept near spot by funding payments | Crypto exchanges | Each has its own lesson: [What Is a Future?](https://learn.tradelabsai.com/markets/what-is-a-future/), [Forwards vs Futures](https://learn.tradelabsai.com/futures/forwards-vs-futures/), [What Is an Option?](https://learn.tradelabsai.com/markets/what-is-an-option/), [Swaps Explained](https://learn.tradelabsai.com/bonds-credit/swaps-explained/), [What Is a CFD?](https://learn.tradelabsai.com/markets/what-is-a-cfd/) and [Perpetual Futures](https://learn.tradelabsai.com/crypto/perpetual-futures/). ## Why derivatives exist Derivatives are often seen as speculative tools, but they began as risk management tools and most of their volume still serves that purpose. - **Hedging.** An airline buys oil futures to lock in fuel costs. A pension fund uses interest rate swaps to match its future payments. A stock investor buys puts as insurance. See [Hedging](https://learn.tradelabsai.com/markets/hedging/). - **Price discovery.** Futures markets, which trade almost around the clock, often signal where stock and commodity prices are heading before the underlying markets open. - **Access.** Derivatives let traders gain exposure to markets that are hard to trade directly, such as a whole stock index or a commodity that must be stored. - **Leverage and speculation.** Because derivatives require only a deposit or premium, traders can take large positions with less capital. This adds liquidity to the market and also risk to the trader. ## Exchange traded vs over the counter **Exchange traded derivatives**, such as listed futures and options, have standard terms and are guaranteed by a clearing house, which steps in if one side fails. Prices are public. **Over the counter (OTC) derivatives**, such as many swaps and forwards, are private contracts between two parties. They can be tailored but carry **counterparty risk**: the chance the other side cannot pay. Since the 2008 crisis, many standard OTC derivatives must be cleared centrally and reported to regulators. See [Clearing Houses and Central Counterparties](https://learn.tradelabsai.com/market-structure/clearing-houses/) and [Market, Credit and Counterparty Risk](https://learn.tradelabsai.com/portfolio/counterparty-risk/). ## How leverage works in derivatives **Example: Leverage through a derivative** Buying $50,000 of an index outright requires $50,000. Gaining the same exposure through futures might require a margin deposit of around $3,000. If the index rises 2%, both positions gain $1,000. On the outright purchase that is 2%; on the futures margin it is about 33%. If the index falls 2%, the futures trader loses the same 33% of their deposit. This is the core idea: derivatives multiply exposure relative to the money put up, which magnifies results in both directions. See [Leverage](https://learn.tradelabsai.com/markets/leverage/). ## Risks of derivatives - **Leverage risk:** losses can exceed the initial deposit for futures, CFDs and sold options. - **Complexity:** options in particular depend on several factors, including time and volatility, so the position can lose value even if the underlying moves the right way. - **Liquidity risk:** some contracts trade thinly, especially far from the current price or date. - **Counterparty risk:** for OTC contracts and offshore brokers. - **Expiry:** most derivatives have a deadline, so timing matters as well as direction. Warren Buffett famously called derivatives "financial weapons of mass destruction" in a 2002 letter to shareholders, referring to the hidden risks of large OTC positions. The same tools, used with clear limits, are also how farmers, airlines and fund managers protect themselves every day. Every derivative is built on a legal agreement between two sides; the [What Is a Contract?](https://learn.tradelabsai.com/markets/what-is-a-contract/) lesson explains what a contract specifies and why standardisation matters. ## Frequently asked questions ### Are derivatives only for professionals? No. Listed options and futures are available to individuals through brokers, often after an approval process. They do require understanding before use. ### Is a stock a derivative? No. A stock is direct ownership in a company. Options and futures on that stock are derivatives. ### Why are derivatives considered risky? Because they often involve leverage and can lose value quickly, sometimes more than the amount invested. The risk depends on how they are used. ## Sources - U.S. Commodity Futures Trading Commission, [Learn and protect](https://www.cftc.gov/LearnandProtect) - Wikipedia, [Derivative (finance)](https://en.wikipedia.org/wiki/Derivative_%28finance%29) ## Continue learning - Next lesson: [What Is a CFD?](https://learn.tradelabsai.com/markets/what-is-a-cfd/) - Previous lesson: [What Is an Option?](https://learn.tradelabsai.com/markets/what-is-an-option/) - Related: [What Is an Option?](https://learn.tradelabsai.com/markets/what-is-an-option/): An option is the right, not the obligation, to buy or sell at a set price before a set date. Learn calls, puts, premiums, strikes and how options gain or lose value. - Related: [What Is a Future?](https://learn.tradelabsai.com/markets/what-is-a-future/): A futures contract is an agreement to buy or sell something at a set price on a future date. Learn how futures work, margin, leverage, settlement and who uses them. - Related: [Swaps Explained](https://learn.tradelabsai.com/bonds-credit/swaps-explained/): A swap exchanges one stream of cash flows for another. Learn the main types, from interest rate and currency swaps to credit, total return and commodity swaps. - Related: [What Is a CFD?](https://learn.tradelabsai.com/markets/what-is-a-cfd/): A CFD lets you trade price moves without owning the asset. Learn how contracts for difference work, margin, overnight costs, where they are legal and the risks. - Related: [Hedging](https://learn.tradelabsai.com/markets/hedging/): Hedging means taking a position that offsets the risk of another. Learn how hedges work with options, futures and correlated assets, their costs and limits. - Related: [Leverage](https://learn.tradelabsai.com/markets/leverage/): Leverage lets you control a larger position with less money. Learn how leverage ratios work, how they magnify gains and losses and how to use leverage safely.