Derivatives

A derivative is a contract whose value is derived from the price movements of an underlying asset — a stock, a commodity, an interest rate, a currency, an index, or another derivative. The three families that matter are:

Futures

A bilateral obligation to buy or sell a specified asset at a specified price on a specified future date. Traded on exchanges with daily mark-to-market and margin posting.

Options

A right (not an obligation) to buy (call) or sell (put) the underlying at a stated strike price on or before expiration. The buyer pays a premium; the writer collects it and takes on the obligation.

Swaps

Bilateral exchanges of cash flows over a term, calculated on a notional amount that never changes hands — most often floating-rate interest for fixed. The largest derivatives market in the world by notional, and one you access almost entirely through funds and structured notes: bilateral swaps generally require “eligible contract participant” status, meaning more than $10 million in assets.

Derivatives are leverage instruments by nature: a small premium or margin deposit controls a much larger notional exposure. Used carefully they hedge concentrated positions, lock in prices for future cash needs, or reshape a portfolio’s risk profile without forcing taxable sales of the underlying. Used carelessly they take down accounts very quickly. The mechanics of options (strategies, Greeks, taxation), futures (rolls, basis, hedging tactics), swaps, and the tax regime that separates the favorable instruments from the rest live in their own chapter: see chapter “Derivatives”.