Derivatives: Options & Futures
Powerful financial instruments for hedging, speculation, and leverage
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Derivatives are financial contracts whose value is "derived" from an underlying asset—stocks, commodities, currencies, or interest rates. They're the most powerful and dangerous tools in finance, offering massive leverage, precise hedging, and catastrophic risk.
The two foundational derivatives are options (the right, but not obligation, to buy/sell) and futures (the obligation to buy/sell at a future date). Together, they form a market larger than global GDP.
Why Derivatives Exist
Airline buys oil futures to lock in fuel costs. Farmer sells wheat futures to guarantee price. Reduce uncertainty, protect against losses.
Trader buys call options predicting stock will rise. Uses 10x leverage to amplify gains (and losses). Pure profit-seeking, high risk.
Derivatives create leverage—control $100k of assets with $10k. This amplifies both gains and losses. Used wisely, they manage risk. Used recklessly, they've caused trillion-dollar crises (2008, LTCM, Barings Bank).