Build a Better Process

Derivative Security Definition and Quiz

While popular, this asset type gets a bad name for being beyond the understanding of the news media and general population.
  1. Define - Define derivative securities.
  2. Context - Use derivative security in a sentence.
  3. Quiz - Test yourself.
face pic by Paul Alan Davis, CFA
Updated: February 17, 2021
Payoffs for derivative securities are often non-linear which makes them more difficult to model.

Outline Back Tip Next

/ factorpad.com / fin / glossary / derivative-security.html

An ad-free and cookie-free website.

Derivative Security for Investment Modeling


A Derivative Security is an investment like an options or futures contract that 'derives' it's value from another asset such as a stock, bond or currency.

Likely the simpleist example of a Derivative Security is a call option on a stock. With a call option, the buyer has the right to buy a stock at a specified 'strike-price' for a period of time. The seller is obligated to sell at that price. If the stock price does not move in favor of the buyer by the expiration date then the option expires worthless and the buyer has lost the premium paid. As a result the payoff of a derivative like an options contract is not linear.

Synonym: financial derivatives

For context, derivative securities are commonly used at institutional firms and banks as a risk management tool. So firms use derivatives to offset the risk of future changes in the price of commodities, equities, interest rates and currencies.

In a Sentence

Kay:  Couldn't your client use a derivative security to protect him from downside risk?
Jim:  Yes, but I'd have to explain it so he understands it. That's the downside.


Many terms have 4-5 minute videos showing a derivation and explanation. If this term had one, it would appear here.

Videos can also be accessed from our YouTube Channel.

Video Script

If this term had a video, the script would be here.


Click box for answer.

Starbucks might be long coffee futures to lock in known prices to make its future operating income more stable. | True or False?


Because payoffs can be magnified with derivatives, they are often used for speculation when an investor has a lot of conviction. | True or False?


Questions and Comments?

Still unclear on Derivative Security? Try out the course Quant 101.

Related Terms

Our trained humans found other terms in the category investment vehicles you may find helpful.

What's Next?

Our YouTube Channel offers valuable investment and technology training. Subscribe at YouTube now so you're notified about new content.

Outline Back Tip Next

/ factorpad.com / fin / glossary / derivative-security.html

derivative security
derivative investment
derivative trading
financial derivatives
derivative financial instrument
derivatives trader
stock derivatives
derivative instruments
equity derivatives
investing in options
investing in futures
derivative contract
investment vehicles
types of investments
derivative products
financial derivatives explained
derivative security tutorial
derivatives defined
common derivatives
financial instrument examples
basic derivatives
investment modeling

A newly-updated free resource. Connect and refer a friend today.