What is a derivative?

A derivative is a contract whose value is derived from something else — the underlying. The underlying can be a stock, an index, a currency pair, a commodity, an interest rate, or even another derivative. You are not trading the asset itself; you are trading a contract that references its price.

Why derivatives exist

Two distinct purposes drive the whole market, and they are worth separating clearly:

• Hedging — reducing an existing risk. A farmer who will harvest corn in three months can lock in a selling price today, removing the danger that prices collapse before the harvest.
• Speculation — taking on risk to seek profit. A trader with no corn at all can take the opposite side of that contract, betting prices will rise.

The same instrument serves both. For every hedger transferring risk away, there is usually a speculator willing to absorb it.

The core idea: leverage and obligation

Most derivatives let you gain exposure to a large notional value while putting up only a fraction of it. That is powerful and dangerous in equal measure — it magnifies both gains and losses relative to the cash you commit.

Some derivatives create an obligation (a future to deliver, a forward to settle), and some create only a right (an option to exercise, or walk away). Knowing which is which is the single most important distinction in this entire track, because it determines your maximum loss.