A derivative (in financial terms) is any asset whose value is related to the value of an underlying asset. The metaphor of velocity and acceleration works well, because a small change in one (acceleration) results in a major change in the other, and so it is the case with financial derivatives. The 2008 financial crisis involved bad choices (subprime loans) that were made worse by concealment (in large bonds called CDOs) that was made MUCH worse by insuring said bonds (derivative) and underestimating the risk posed by devaluation of the underlying asset (houses). Leverage is a term that implies a larger profit and a smaller bet; reverse leverage, a made-up term, is when the bets all go wrong at the same time. For many derivatives like call options, the buyer stands to lose only the price of the option. Derivatives are NOT inherently bad (although Mr. Buffett did call them "financial weapons of mass destruction," he uses them too). BUT the investor should be aware of the downside risk associated with some of these bets. In 2008, the AIG downside risk was almost infinite, and the lack of a solvent insurer caused PANIC. So you might hear of derivatives used in a pejorative way. Look up Long Term Capital Management for another apocryphal story of making a bad bet with other people's money. Back to more mundane uses of derivatives... People like to trade and they have exchanged goods and services since ancient times. A negotiated exchange between two parties is a contract. Long ago, contracts for the future price of a commodity, like olive oil, were used to protect the grower from weather issues or demand issues. This is thought to be the origin of futures contracts. At least some of the "crop" could be hedged, before the crop even became available. Some wine stores sell futures on Bordeaux wine in a similar way. Note that the true example of a hedge is when one protects the upside and downside of a volatile market, as in a currency hedge. This has almost nothing to do and downside of a volatile market, as in a currency hedge. This has almost nothing to do with so-called hedge funds of today, which are private investors that are pretty opaque and can bet on just about anything. Look up the difference between trading Futures and Forward Contracts- same idea, but in one case, one has to actually take delivery of the goods or commodities! Be careful if this is pork bellies! Options are futures contracts for shares of stock. They have been in the news for years as a way for employees of tech companies to get rich. Now there are more restrictions on options, but there was a time when companies handed them out like candy and did not expense the cost on the balance sheet. Times change. Options of public stocks are traded on the Chicago Board Options Exchange. A call option is the right to purchase a certain number of shares (e.g. 100) within a specified timeframe and at a designated exercise price." If the share price does not reach the exercise price, the option simply expires worthless. Most call options expire worthless. So why do people buy them? Because for a relatively small amount of money, the owner might hit it big IF the stock really goes up (i.e. leverage). For example, if you were holding a "lot" (equivalent to 100 underlying shares) of Amgen call options with the shares at $162/share and the share price rose to $182/share before the option expires, then a savvy investor would exercise the call options and quickly pocket $2,000 ($20/share x 100 shares). I would guess the option may have cost $200 for the "lot," and so the net would be $1800 (9x return). Not bad! Put options work similarly except the bet is that the underlying stock, index or commodity will go down in price (i.e. be less expensive) in the future. And "lower price" means going all the way down to ZERO, and so the downside risk of a put option is very high. As long as one owns the underlying stock (a covered call), the downside risk to writing (i.e. selling) a call is simply that you get some shares called away- shares that perhaps you were ready to sell anyway. Writing covered calls is a way to hedge an underlying position and bring in some revenue while you hold the stock, though it limits your upside if you have to sell the underlying shares later at the exercise price. Derivatives can be useful instruments for hedging if used correctly. One of the lessons of 2008 is that trillion dollar bets made on the sidelines can put our entire financial system at risk without the counterparty risk being known. In spite of the political backlash on" bailing out the big banks," both President Bush and Obama quickly realized, as did most of Congress, that frozen credit markets and lack of lending would benefit no one and would presage a depression for sure. Few political leaders would want their names attached to such a decision. Did a CDO exchange ever come to fruition?