Who this entry is for — Readers who need to understand what a contract promises before considering leverage, expiry or price direction.
A derivative is a contract whose value depends on an underlying, rate, index, event or other reference. It does not necessarily confer ownership of the underlying: it creates rights and obligations defined by the contract specifications.
In plain language — “Derivative” is a family, not a single product. Futures, options, swaps and CFDs have different payoffs and risks.
Five questions before the product name
- Underlying or reference — stock, index, rate, currency, credit, commodity or something else?
- Payoff — linear, optional, conditional or an exchange of cash flows?
- Term — which rules govern expiry, exercise, renewal or close-out?
- Settlement — delivery, cash payment, margin and mark-to-market?
- Counterparty and infrastructure — is the contract OTC or traded/cleared under the rules of a venue and clearing house?
Main families
| Family | Essential right or obligation |
|---|---|
| standardized obligation, with expiry and margin | |
| Forward | customized OTC obligation for a future date |
| buyer's right and seller's obligation if exercised or assigned | |
| Swap | exchange of cash flows under agreed dates and formulas |
| settlement of the change in value with the provider |
The precise legal classification depends on the jurisdiction and contract. The name of the underlying is not enough: a stock, an option on the stock and a CFD on the stock are not the same instrument.
Leverage, margin and loss are not synonyms
Many derivatives produce substantial economic exposure relative to the capital initially committed, but their mechanics differ:
- a future uses initial margin and daily variation margin;
- an option buyer pays a premium and has a nonlinear payoff;
- an option seller may face very different obligations and margin;
- a CFD follows the provider's margin and financing rules;
- a swap may require collateral under the applicable agreements and clearing arrangements.
Leverage magnifies changes relative to capital, but does not by itself measure maximum loss. Assessing that loss requires the payoff, notional amount, gaps, liquidity, close-out, collateral and counterparty risk.
Venue and counterparty
“Derivative” does not automatically mean OTC. Futures are standardized and traded on organized venues; many options are exchange-traded, while forwards, swaps and CFDs may be OTC. Clearing, custody, intermediary, issuer and counterparty are distinct roles.
The spot market may also be exchange-traded or OTC: the central difference remains the right held and how it settles.
Comparison example
An equity basket may be represented by an index. The index is a measure; an ETF is a fund share; a future is a contract with a multiplier, margin and expiry; an option adds a strike and conditional payoff; a CFD creates a claim against or liability to the provider. Similar exposures do not make the rights interchangeable.
Sources
- European Securities and Markets Authority, MiFID II, Annex I — Lists of services and activities and financial instruments — EU categories of options, futures, swaps, forwards and other derivatives.
- Bank for International Settlements, About derivatives statistics — statistical classification by underlying risk and OTC/exchange market.
- U.S. Commodity Futures Trading Commission, Futures Market Basics — futures obligations, clearing, margin and settlement.
- U.S. Securities and Exchange Commission, Investor.gov, An Introduction to Options — call and put rights and obligations.