The overall derivatives market has five major classes of underlying assets.

• Credit derivatives, whose value is derived from the credit risk on an underlying bond, loan or any other financial asset. The credit risk is on an entity, known as the reference entity, which can actually be any form of legal entity which has incurred debt.
  

• Equity derivatives, where the value is at least partly derived from one or more underlying equity securities, like options and futures.
  

Other examples of underlying exchangeables are: property (mortgage) derivatives (whose value is the value of an underlying real estate asset); economic derivatives (that pay off according to economic reports); freight derivatives (trading in future levels of freight rates, for dry bulk carriers and tankers); inflation derivatives (used to transfer inflation risk from one counterparty to another); weather derivatives (a risk management strategy to reduce the risk associated with adverse or unexpected weather conditions); insurance derivatives (whose value derives from an underlying insurance index or the characteristics of an event related to insurance).

As an investor you should carefully weigh the risks of using derivatives since losses can be greater than the money put into these instruments.

But if you decide to invest in derivatives, you can open an account at a discount or full-service brokerage and indicate your intention to trade options and derivatives within that account.

Or you can have stocks in your portfolio that you can write options on. When you write a call option you are offering the underlying stock for sale based on a specific price, known as the strike price, within a specific time frame. If you own the underlying asset it is known as a covered call; if you don’t own the asset it is known as a naked call. Writing covered call options is a good way to earn additional income from your investment portfolio.

You can also select the month you want the option to expire, the longer the time frame, the more income you will receive.

And you can sell your option into the market, hoping that the option will expire worthless in the buyer’s hands.

Remember, when dealing with such complicated and risky investment instruments you should always seek out professional advice.

Derivatives can be based on different types of assets such as commodities, equities (stocks), bonds, interest rates, exchange rates, or indices (such as a stock market index, consumer price index (CPI). Their performance can determine both the amount and the timing of the payoffs.

The main use of derivatives is to minimize risk for one party while offering the potential for a high return (at increased risk) to another.

Derivatives themselves are not to be considered investments since they are not an asset class. They simply derive their values from assets such as bonds, equities, currencies etc. and are used to either hedge those assets or improve the returns on those assets.

The derivatives market can be divided into two, exchange traded derivatives and over-the-counter derivatives. The legal nature of these products and the way they are traded are different, though many market participants are active in both.

Over-the-counter (OTC) derivatives are contracts traded directly between two parties, without going through an exchange. Products such as swaps, forward rate agreements and exotic options are almost always traded in this way. The OTC is the largest market for derivatives and is made up of banks and other sophisticated parties, such as hedge funds.

Swaps are agreements between two parties to exchange a series of payments on predetermined terms. The cash flows are calculated over a notional principal amount, which is usually not exchanged between counterparts. Consequently swaps can be in cash or collateral.

Swaps can be used to hedge certain risks such as interest rate risk, or to speculate on changes in the expected direction of underlying prices.

Forward contracts are traded in over-the-counter market usually between two financial institutions or between a financial institution and one of its clients. One of the parties agrees to buy the underlying asset on the certain specified future date for a certain specified price, meaning it takes the long position. The other party agrees to sell the asset on the same date for the same price, that is it takes the short position. The most popular are the forwards on foreign exchange.

Exotic options are derivatives with more complex and complicated features than commonly traded products (vanilla options).

Exchange-traded derivative contracts (ETD) are obviously traded via derivatives exchanges or other exchanges. The derivative exchange acts as an intermediary to all related transactions and takes initial margin from both sides of the trade to act as a guarantee.

The world's largest derivatives exchanges (by number of transactions) are the Korea Exchange (which lists KOSPI Index Futures & Options), Eurex (which lists a wide range of European products such as interest rate & index products), and CME Group (made up of the 2007 merger of the Chicago Mercantile Exchange and the Chicago Board of Trade).