Deciphering Derivatives
Derivatives are investments that derive their value from something else. On their own, they really aren't worth anything. Their value comes from an underlying asset and changes in its value. For that reason, every derivative is the same thing as a bet. Derivative traders are gambling, usually on minute movements affecting the assets that lie beneath them.
Have you ever seen the movie Trading Places? The two men who make Eddie Murphy and Dan Aykroyd trade places are derivatives traders who invested heavily in orange juice futures. When a fictional cold snap hit Florida and those futures became worthless, those traders lost it all.
Every derivative is a contract agreement between two parties. The most common derivative contracts are options, futures, swaps, and forward contracts. And these contracts aren't written only on other investment securities, although that's the norm. Derivative contracts can be written on things like weather data (will it rain in Florida in August?), holiday retail sales, or interest rates. But most derivatives are written on investment-related items: stocks, bonds, currencies, commodities, and even on market indexes.
