Derivative security

A derivative security, also known as a derivative, is a financial instrument valued according to the price of another asset. This price is called the underlying price. Since a derivative is linked to another asset–for example a share or currency– changes in the prices of the underlying asset affect the derivative’s value.

A derivative may not have its own value, but certain derivatives, such as futures, are traded in the same way as assets.

It is possible to create a derivative agreement for any kind of security. The main factor is a link to an underlying asset.

Investors can profit off derivatives if they already expect certain underlying assets to move in a certain way. There are some cases in which slight changes in the underlying can cause big movements in the value of the derivative. An investor who chooses such a derivative benefit from the leverage that this provides.

Derivatives may also be labelled as vanilla derivatives or exotic derivatives. Vanilla derivatives are simple and common; exotic derivatives are specialized.