In very simple terms a derivative is an instrument that derives its value from another one.

There are three basic types – the future, the option and the swap. These tend to be used by mainly institutional clients. For a retail investor the nearest thing to a future is a spread bet. This allows you to place up and down bets on assets such as shares or commodities without having to own, or pay for, the underlying assets. Indeed often the amount of cash that you commit to a derivative position is a relatively small proportion of the value of the underlying asset. In this sense derivative positions are “geared” – big profits and losses can be generated from small initial investments. For this reason they can be dangerous for novice investors.