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Financial derivatives are basically contracts between two different parties. The contracts say that the value of the derivative will be determined by changes to other variables. These variables can be a number of things, including financial products such as equities and bonds and physical products like commodities, as well as other things which are difficult to predict - like the weather or the lifespan of a population.

Derivatives are often used as insurance and protect against risk. As an example of this, Credit Default Swaps (CDS) specify that if a loan defaults, the holder of the CDS will still get compensated.

Futures contracts were the earliest form of derivatives. Futures contracts were created so that people who purchased certain goods could have an element of control over the price in the future. As an example, farmers selling wheat could enter into a contract with the people who purchased the wheat to agree that in three months, they would be able to sell wheat at an established price. By doing so, they protect themselves against any risk of a drop in the wheat price during those three months.

Other forms of derivatives that you may need to deal with in a derivatives career include swaps and options.

Swaps are a simple exchange of one type of product for another. One of the most common is currency swaps, where loans and/or the interest payments on loans are swapped from one currency into a different one.

Options are contracts which let one party buy or sell assets to another at a set cost at a defined point in the future. Unlike futures contracts, there are no obligations to invoke an options contract. Using the same example, a buyer of wheat would have the right to purchase three tons of wheat at the established price if it makes sense to him financially, but is not required to do so if it doesn't. Anyone who holds an option must pay for the privilege.

The two types of options mentioned above are different. Options which give the holder the right to buy something are "call options." Options which give the holder the right to sell something are "put options."

Simple derivatives are usually traded on exchanges. Complex derivatives have historically been traded over the counter (OTC) between the two parties involved in the contract. This is changing, however, as governments look to create transparency in the derivatives market.

Leading up to the 2008 financial crisis, derivative products grew increasingly complex and proliferated with products such as collateralized debt obligations and synthetic derivatives (derivatives based upon derivatives). As a result, many people lay blame for the crisis on derivatives products and the wrong impression that risk was no longer an issue.