Derivatives do not have value on their own—their price depends on something else. The underlying asset can be almost anything: gold, oil, stock prices, exchange rates, or even volatility. The purpose of a derivative is to allow investors to manage risk, speculate on price changes, or gain exposure to markets without owning the asset directly.
The most common types of derivatives are futures, options, forwards, and swaps. Each works differently, but all allow parties to lock in prices, transfer risk, or take a position on how the market will move. Because derivatives can be customized or traded on exchanges, they serve both institutional users managing large exposures and traders seeking opportunities.
Derivatives play a major role in global finance. Companies use them to hedge fuel costs, interest rates, or currency exposure. Investors use them to create strategies, control risk, or enhance returns. Although powerful, derivatives can also be complex and require careful risk management.
Derivatives help businesses and investors manage uncertainty, stabilize costs, and access markets efficiently. They support risk reduction and can offer more flexibility than simply buying or selling the underlying asset.
The four major types are:
Futures and forwards lock in prices for future transactions, while options give the right—but not the obligation—to buy or sell at a set price. Swaps allow parties to exchange cash flows, such as fixed and floating interest rates. Each derivative serves a different purpose and suits different risk needs.
Companies use derivatives to protect themselves from unpredictable price movements. For example, airlines hedge fuel costs with oil futures, manufacturers hedge metal prices, and global businesses hedge currency exposures with forwards or options. By locking in prices, companies reduce uncertainty and avoid negative impacts from sudden market shifts.
Derivatives can carry leverage, meaning a small change in the underlying asset can lead to large gains or losses. Some derivatives are traded privately (over-the-counter), which can introduce counterparty risk if one party fails to meet obligations. Complex structures can also be misunderstood or misused. When used responsibly, however, derivatives are effective risk-management tools.
A company worries that interest rates will rise and increase its borrowing costs. It enters an interest rate swap to exchange its variable-rate payments for fixed-rate payments, stabilizing expenses regardless of market changes.
