The mass majority of investors have stocks and bonds, or annuities. There are not many investors who ever touch derivatives.
Derivatives have been around a long time, particularly in the farming industry, where one party (the farmer) agrees to sell his goods (livestock, crops) to someone else (who is known as the counterparty) at a specific price and at a specific date. The farmer does this because it hedges him against the possibility of his goods dropping in value once harvest season comes. The counterparty accepts this deal because he hopes the value will increase by the time the specific purchase date arrives.
A derivative means that the price of the contract is derived by another asset. You can have derivatives on almost anything in the form of what is called a “futures contract.” Another way to purchase derivatives is through options, otherwise known as puts and calls.
Now that you have a basic grasp of what a derivative actually is, allow Lou Scatigna, CFP to provide you with a deeper understanding of the role that derivatives play in finance and investing.
Your financial advisor is like your doctor. You better have the right one, or you are going to be in trouble.