What is a Derivatives Exchange?

A derivatives exchange is a financial market where people can buy, sell, and swap derivatives, a special kind of financial instrument. There are many kinds of derivatives, but all include the basic format of a contract with a value based on an underlying asset. The contract itself has no intrinsic worth, but people can buy and sell the contracts to access their underlying value. Trading on a derivatives exchange can include so-called “vanilla” or “exotic” derivatives and it is possible to engage in a variety of investment activities, some of which require advanced trading skills.

In a common example of a vanilla derivative, an oil company could purchase a futures contract, giving it the right to purchase a set amount of oil on a specific date in the future for a particular price. The oil company may do this with the goal of locking in a good price, or to be able to secure a price without having to buy the oil immediately and store it is needed. The company could later decide to trade the contract on the secondary market, selling it to someone else, who can in turn trade it.

People trading on a derivatives exchange want to take advantage of rising and falling prices of underlying assets, including projected price shifts. They have no intent of taking possession of the assets named in the contract, and are instead interested in the profits to be made on price variations. This type of trading requires the ability to follow industries closely, accurately predict market movements, and trade at the right time.

Some traders on a derivatives exchange represent themselves. They use their investment skills to build up mixed portfolios, including derivatives, and may handle a large volume of trades. Others represent institutions and individual investors, executing trades on behalf of other people. This work requires a special duty of care, as the trader must exercise more caution when working with another person's money.

Financial publications may track activity on a derivatives exchange. They have an interest both in the volume and nature of trading, and what the trades have to say about projected prices for commodities. For example, if there's a rapid spike in corn futures, this may indicate a potential rise in the price of corn in the future, as the high trading activity suggests there may be a mismatch between supply and demand in the market.