Here, we slash through the BS and put common personal finance expressions in plain terms.
Sorry if the word “derivative” brings back unpleasant memories from calculus classes of yore. In finance, a derivative is a contract whose value is tied to, or derives from, an asset (like a stock) or grouping of assets (like an index fund).
Futures, forwards, and options are all examples of derivatives because their values hinge on some underlying asset, from oil to gold to stocks.
Example: Last April, analysts were sweating from their home offices trying to figure out what to do with millions of barrels of oil that were about to land on their front porches.
- Investment firms entered into futures contracts that would let them either 1) acquire oil later on or 2) contract with another party before the expiration date.
- They went for option No. 2 because investment firms want profits, not oil.
- Oil futures—derivatives for oil—dipped into the negatives because there was virtually no demand for oil. In other words, investors who bet on selling oil futures instead had to pay to avoid taking delivery of actual oil.
In case you’re wondering, oil futures contracts are no longer negative—and are on the rise.