Derivatives Defined

In a previous post I mentioned derivative. Someone asked me what that actually meant. Aha! An idea for a blog post. So here's our lesson for today.

Energy Lesson

A derivative is a financial contract.

The value of this contract comes from another security, for instance, a stock, bond, currency, a commodity, or a market index like the S&P 500.

These are the most common types of derivatives: options, futures, and securities backed by mortgages. I've traded all kinds.

Derivatives are often used to hedge your risk. (Though you may not think you know what a Financial Hedge is, just think about the phrase "hedging your bets" and you'll have a basic understanding of why a hedge is used.)

A hedge is put on to help companies limit their financial exposure due to fluctuations in the currency exchange rate or the volatility of the fuel prices.

Derivatives, like any financial tool, can be risky if not properly understood and managed by someone with expertise. I've used them often and successfully, but many people don't have enough experience with them to use them wisely.

Bringing Meaning To Madness

Like any tool, experience and knowledge is required to wield it well.