Derivatives are financial products, such as futures contracts, options, and mortgage-backed securities. Most of derivatives' value is based on the value of an underlying security, commodity, or other financial instrument.
For example, the changing value of a crude oil futures contract depends primarily on the upward or downward movement of oil prices.
An equity option's value is determined by the relationship between its strike price and the value of the underlying stock, the time until expiration, and the stock's volatility.
Certain investors, called hedgers, are interested in the underlying instrument. For example, a baking company might buy wheat futures to help estimate the cost of producing its bread in the months to come.
Other investors, called speculators, are concerned with the profit to be made by buying and selling the contract at the most opportune time. Listed derivatives are traded on organized exchanges or markets. Other derivatives are traded over-the-counter (OTC) and in private transactions.
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