A derivative is a financial product that enables traders to speculate on the price movement of assets without purchasing the assets themselves. Because there is nothing physical being traded when derivative positions are opened, they usually exist as a contract between two parties.
Most derivatives involve margin trading, and offer a larger amount of flexibility when it comes to using different trading strategies across a variety of asset classes. They allow the opportunity to trade on volatility itself, instead of relying on positive moves in an asset’s price.
Derivative products come in a variety of forms, with huge differences between them. Some of the major derivatives used by traders are:
- CFDs (or contracts for difference): an agreement between two parties to pay the difference in price of an asset between the time a position is opened and when it is closed
- Options: give traders the right – but not the obligation – to purchase or sell an asset at a certain price within a certain timeframe
- Binary options: offer only two possible (yes/no) outcomes about the future price of an asset. The trader must choose the correct outcome in order to earn a defined payout.