Understand how derivatives work?

I have already derivatives trader for the majority of my career. I have noticed during this period that the word "derivative" has garnered some very negative connotations. The fact that the issue is that the derivative term has different meanings and can indicate a wide range of financial instruments. Let's start with a basic definition of a derivative.

A derivative is a financial instrument, as an option or futures contract, whose value is derived in part from the price of another security which is the underlying. Don't assume technical definition together an enormous amount of light on the true meaning of the derivative. In plain language, a derivative is a bet as to whether the value of the underlying security, which can be a stock, bond or financial index will increase or decrease by a specified date. Derivatives are commonly used for the protection of assets values and things like stocks or potential future markets. In fact, derivative is an umbrella term for a broad category of financial products. Some of these products, such as futures and options are clearly defined and enjoy a relatively broad understanding.

On the other hand, there are classes of derivatives that exist in an environment of murky and poorly understood. These derivatives typically are not traded publicly, but are individual contracts between companies to buy and sell products, or to insure against loss (as in the case of CDS) or to give a company the right to buy a product in the future, a set of values. These non-tradable derivatives can be classified as exotic in nature. From exotic, I mean that they are each unique in a finite state that exists between the two parties. As you probably heard the news, many of these exotic derivatives is poorly understood by both the public and the Government. Further, there were questions raised as to the legality of such compensating products. Incidentally, the new packages of financial regulation proposed by the Government include extensive monitoring and setting of exotic derivatives.

But my job back, work only with the "plain Jane" variety of derivative called forward contracts. Futures contracts are traded on regulated exchanges and there is a high degree of transparency in their daily trading activity. Futures have been around for more than a century and the beginning of derivatives trading date back to rice in Japan in the 17th century. The garden-derived variety, or futures, are well understood and largely traded.

You might be surprised at the wide range of commodities, metals, financial indexes and a host of other unusual futures contracts can be traded. For example, futures, bonds, prices of energy products, meat and a host of other conventions. Generally, these contracts are used for blocking prices for the producers of the products listed above, or investors of the products listed above. Futures allow a producer to lock-in a value so that they can produce an enterprise product and the value for the future in mind.

It is important to understand that effectively regulated sector futures provide a valuable service in the industry. On the other hand, exotic derivatives sometimes resulted in extraordinary losses on derivatives and the latest problem is being caused our country to fall into recession. This article is intended to distinguish between normal, transparent derivatives and exotic derivative contracts that have caused so much trouble for our economy.