Derivatives 101

The term "derivatives" is often used in the world of finance. But for most people, it is just another example of complicated financial jargon. Often used, seldom understood.

Let& #39;s fix that.

Here& #39;s Derivatives 101!

https://abs.twimg.com/emoji/v2/... draggable="false" alt="👇" title="Rückhand Zeigefinger nach unten" aria-label="Emoji: Rückhand Zeigefinger nach unten">https://abs.twimg.com/emoji/v2/... draggable="false" alt="👇" title="Rückhand Zeigefinger nach unten" aria-label="Emoji: Rückhand Zeigefinger nach unten">https://abs.twimg.com/emoji/v2/... draggable="false" alt="👇" title="Rückhand Zeigefinger nach unten" aria-label="Emoji: Rückhand Zeigefinger nach unten">

1/ A "derivative" is just a contract with a value that is based on something else.

Its value is DERIVED from something else.

If I create a contract called the SB that is linked to my # of Twitter followers, that is a derivative. The contract value is derived from my followers.

2/ In financial terms, derivatives are a security that is tied to an another asset - called the "underlying asset."

The underlying asset could be:
https://abs.twimg.com/emoji/v2/... draggable="false" alt="1⃣" title="Tastenkappe Ziffer 1" aria-label="Emoji: Tastenkappe Ziffer 1"> Stocks
https://abs.twimg.com/emoji/v2/... draggable="false" alt="2⃣" title="Tastenkappe Ziffer 2" aria-label="Emoji: Tastenkappe Ziffer 2"> Bonds
https://abs.twimg.com/emoji/v2/... draggable="false" alt="3⃣" title="Tastenkappe Ziffer 3" aria-label="Emoji: Tastenkappe Ziffer 3"> Commodities
https://abs.twimg.com/emoji/v2/... draggable="false" alt="4⃣" title="Tastenkappe Ziffer 4" aria-label="Emoji: Tastenkappe Ziffer 4"> Currencies
https://abs.twimg.com/emoji/v2/... draggable="false" alt="5⃣" title="Tastenkappe Ziffer 5" aria-label="Emoji: Tastenkappe Ziffer 5"> Interest Rates

Really anything can be an underlying asset. Get creative!

3/ Derivatives can take on many different forms.

The most common are:
https://abs.twimg.com/emoji/v2/... draggable="false" alt="1⃣" title="Tastenkappe Ziffer 1" aria-label="Emoji: Tastenkappe Ziffer 1"> Options
https://abs.twimg.com/emoji/v2/... draggable="false" alt="2⃣" title="Tastenkappe Ziffer 2" aria-label="Emoji: Tastenkappe Ziffer 2"> Futures/Forwards
https://abs.twimg.com/emoji/v2/... draggable="false" alt="3⃣" title="Tastenkappe Ziffer 3" aria-label="Emoji: Tastenkappe Ziffer 3"> Swaps

We covered the basics of Options in Options 101.

https://twitter.com/SahilBloom/status/1283080850641317889?s=20

I">https://twitter.com/SahilBloo... will soon cover Futures and Swaps to explain what they are and how they work. Stay tuned.

4/ Derivatives are widely used by investors.

The most common use cases are:
https://abs.twimg.com/emoji/v2/... draggable="false" alt="1⃣" title="Tastenkappe Ziffer 1" aria-label="Emoji: Tastenkappe Ziffer 1"> Hedging - offset/protect a position
https://abs.twimg.com/emoji/v2/... draggable="false" alt="2⃣" title="Tastenkappe Ziffer 2" aria-label="Emoji: Tastenkappe Ziffer 2"> Speculation - bet on price moves
https://abs.twimg.com/emoji/v2/... draggable="false" alt="3⃣" title="Tastenkappe Ziffer 3" aria-label="Emoji: Tastenkappe Ziffer 3"> Leverage - amplify a position

Naturally, using derivatives for a hedge is less risky than using them for leverage.

5/ This was a very basic, 10,000-foot overview on derivatives, their common forms, and their use cases.

I will cover the common forms in additional detail (with simple examples, of course!) in future threads.

So that& #39;s Derivatives 101! I hope this was a helpful primer.