What is a derivative?

A derivative is any financial instrument, whose payoffs depend in a direct way on the value of an underlying variable at a time in the future. This underlying variable is also called the underlying asset, or just the underlying. Examples of underlying assets include

$$\begin{tabular}{ll} \textbf{Underlyi... ...te \\ and many others & Weather \\ & Election results \hline \end{tabular}$$

Usually, derivatives are contracts to buy or sell the underlying asset at a future time, with the price, quantity and other specifications defined today. Contracts can be binding for both parties or for one party only, with the other party reserving the option to exercise or not. If the underlying asset is not traded, for example if the underlying is an index, some kind of cash settlement has to take place. Derivatives are traded in organized exchanges as well as over the counter [OTC derivatives]. Examples of derivatives include forwards, futures, options, caps, floors, swaps, collars, and many others.