Who is the issuer in a derivative contract?
While the issuer of the security such as a stock or bond not the short is responsible for the credit risk, the issuer and the short of a derivative is one. In all cases, it is more than likely that a trader is owed securities by an agent such as a broker or exchange or clearinghouse. Legally, only the Options Clearing Corporation clears openly traded options.  With stocks and bonds, brokerages can clear with each other if approved. While a trader is expected to fund margin, the legal responsibility is shared by all in the agent chain.  Clearinghouses are liable to exchanges.  Exchanges are liable to members.  Traders are liable to brokerages.  Both ways and so on. Clearinghouses are usually ultimately liable for counterparty risk to the long counterparty, and the short counterparty is ultimately liable to the clearinghouse. Clearinghouses are not responsible for the credit risk of stocks and bonds because the issuers are not short those securities on the exchange, thus no margin is required.  Credit risk for stocks and bonds is mitigated away from the clearing process.
The basic idea behind a derivative is very simple actually.  It is a contract where the final value depends on (is derived from) the value of something else.  Stock, for instance, is not a derivative because the contract itself is actually ownership of part of a company.  Whereas car insurance is a derivative because the payout depends on the value of something else namely your (and other peoples') cars. The problem with such a simple definition is that it covers such a broad class.  It covers simple contracts like Futures where the end value just depends on the price of something on a future date.  But it extends to contracts complicated enough that people in finance call them Exotics. Derivatives are broadly used for two things reducing risk (sometimes called insurance) and speculation.  A farmer can use derivatives to make sure she gets paid a certain amount for her corn.  A banker can group a bunch of loans together and sell slices to reduce the pain of a particular loan failing.  At the same time people can use the same instruments to speculate on the price of (for example) that corn or those loans and the main advantage is that they don't have to buy the corn or loans directly.  Any farmer will tell you corn can be very expensive to store. Derivatives generally cause problems both individually and sometimes world wide when people don't properly understand the risks involved.  The most famous example being Mortgage-backed Securities and the recent Great Recession.  You can start understand the instruments and their risks by this wonderful Wikipedia article and later perhaps a used collection of CFA books which cover derivatives in great detail. Edit: Michael Grünewald mentioned Hull's text on derivatives a wonderful middle ground between Wikipedia and the CFA books that I can't believe I didn't think about myself. Cart's answer is basically correct, but I'd like to elaborate: A futures contract obligates both the buyer of a contract and the seller of a contract to conduct the underlying transaction (settle) at the agreed-upon future date and price written into the contract. Aside from settlement, the only other way either party can get out of the transaction is to initiate a closing transaction, which means:  The party that sold the contract buys back another similar contract to close his position.  The party that bought the contract can sell the contract on to somebody else. Whereas, an option contract provides the buyer of the option with the choice of completing the transaction.  Because it's a choice, the buyer can choose to walk away from the transaction if the option exercise price is not attractive relative to the underlying stock price at the date written into the contract.  When an option buyer walks away, the option is said to have expired. However – and this is the part I think needs elaboration – the original seller (writer) of the option contract doesn't have a choice.  If a buyer chooses to exercise the option contract the seller wrote, the seller is obligated to conduct the transaction.  In such a case, the seller's option contract is said to have been assigned.  Only if the buyer chooses not to exercise does the seller's obligation go away.  Before the option expires, the option seller can close their position by initiating a closing transaction.  But, the seller can't simply walk away like the option buyer can. There is no one answer to this question, but there are some generalities. Most exchanges make a distinction between the passive and the aggressive sides of a trade.  The passive participant is the order that was resting on the market at the time of the trade.  It is an order that based on its price was not executable at the time, and therefore goes into the order book.  For example, I'm willing to sell 100 shares of a stock at $9.98 but nobody wants to buy that right now, so it remains as an open order on the exchange. Then somebody comes along and is willing to meet my price (I am glossing over lots of details here).  So they aggressively take out my order by either posting a market-buy, or specifically that they want to buy 100 shares at either $9.98, or at some higher price. Most exchanges will actually give me, as the passive (i.e. liquidity making) investor a small rebate, while the other person is charged a few fractions of a cent.  Google found NYSEArca details, and most other exchanges make their fees public as well.  As of this writing the generic price charged/credited: But they provide volume discounts, and many of the larger deals do fall into another tier of volume, which provides a different price structure. "MD-Tech answered: The answer is in your question: derivatives are contracts so are enforced in the same way as any other contract.  If the counterparty refuses to pay immediately they will, in the first instance be billed by any intermediary (Prime Broker etc.) that facilitated the contract. If they still refuse to pay the contract may stipulate that a broker can ""net off"" any outstanding payments against it or pay out using deposited cash or posted margins. The contract will usually include the broker as an interested party and so they can, but don't need to, report a default (such that this is) to credit agencies (in some jurisdictions they are required to by law). Any parties to the trade and the courts may use a debt collection agency to collect payments or seize assets to cover payment. If there is no broker or the counterparty still has not paid the bill then the parties involved (the party to the trade and any intermediaries) can sue for breach of contract. If they win (which would be expected) the counterparty will be made to pay by the legal system including, but not limited to, seizure of assets, enforced bankruptcy, and prison terms for any contempts of court rulings. All of this holds for governments who refuse to pay derivatives losses (as Argentina did in the early 20th century) but in that case it may escalate as far as war. It has never done so for derivatives contracts as far as I know but other breaches of contract between countries have resulted in armed conflict. As well as the ""hard"" results of failing to pay there are soft implications including a guaranteed fall in credit ratings that will result in parties refusing to do business with the counterparty and a separate loss of reputation that will reduce business even further. Potential employees and funders will be unwilling to become involved with such a party and suppliers will be unwilling to supply on credit. The end result in almost every way would be bankruptcy and prison sentences for the party or their senior employees. Most jurisdictions allow for board members at companies in material breach of contract to be banned from running any company for a set period as well. edit: netting off cash flows netting off is a process whereby all of a party's cash flows, positive and negative, are used to pay each other off so that only the net change is reflected in account balances, for example: company 1 cash flows netting off the total outgoings are 3M + 500k = 3.5M and total incomings are 1.2M + 1.1M + 1.2M = 3.5M so the incoming cash flows can be used to pay the outgoing cash flows leaving a net payment into company1's account of 0." "The Wikipedia page for Repurchase Agreement has two relevant pointers on this topic:  The legal title for any securities used in a repo actually pass from seller to buyer during the term of the agreement. In basic terms this means that if one sells a bond on repo with a promise to buy it back, then the ownership actually transfers to the buyer for that period of time.  If a coupon is paid during this time period, it can either go to the buyer or the seller. Usually, the coupon payment goes to the initial owner of the security pre-repo (our ""seller""). But sometimes the repurchase agreement will specify otherwise. So, again in basic terms, usually the repo seller/initial security owner receives any payments made during the term of the repurchase agreement. (Both points are in the first paragraph of the section ""Structure and Terminology"".)" Do you know what a derivative is? Did you know it is possible to own derivatives of assets that you do not own? Did you know there are derivatives of derivatives? Did you know that the derivatives market is many times larger than all the money on earth?  At some point modern markets became so many steps removed from the basic principles of business that they no longer make any sense. Most trades today are done by supercomputers with high speed connections running incredibly complex algorithms invented by the most brilliant mathematicians money can buy. All of whom are studying what each other are doing and trying to manipulate each others algorithms in such a way as to make money faster and harder than the other guy. It is way beyond what any human can comprehend let alone regulate.  Teams of the smartest people on earth can kind of grasp a tiny sliver of what is going on. No. Such companies don't exist. Derivative instruments have evolved over a period and there is a market place, stock exchange with members / broker with obligations etc clearly laid out and enforceable. If I understand correctly say the house is at 300 K. You would like a option to sell it to someone for 300 K after 6 months. Lets say you are ready to pay a premium of 10K for this option. After 6 months, if the market price is 400 K you would not exercise the option and if the market price of your house is 200 K you would exercise the option and ask the option writer to buy your house for 300 K. There are quite a few challenges, i.e. who will moderate this transaction. How do we arrive that house is valued at 300K. There could be actions taken by you to damage the property and hence its reduction in value, etc. i.e. A stock exchange like market place for house is not there and it may or may not develop in future. A derivative in finance is simply any asset whose value is based on the value of another asset or based on the value of a group of assets. A derivative contract is a type of contract (usually a 'standardized contract') with specific payout instruction based on the price changes of a different asset. The basic idea is that it becomes easier to make a claim to an asset or property (and profit from this claim), without needing to physically transfer it (or even the title to said asset), and use much less capital to do so (reduce risk). They become problematic when multiple people may have claims to the real asset, or when the value of the derivatives changes very quickly or are hard to calculate. There are also liquidity problems the further you get from the real asset. This is not a problem for all kinds of derivatives contracts. And you must recognize that derivatives are used colloquially in a way that has nothing to do with reality to cause fear in people/investors that are not financially savvy. Many derivatives also have dubious or no economic purposes such that regulators don't allow them to be traded since they can't see how it is different from gambling. This is seen in financial markets that are less liberalized or cultures with puritanical backgrounds. Typically the trick is to convince regulators that the derivative or financial product helps with reducing risk and hedging and it will get approved. I've mentioned some terminology, but this depends specifically on what kind of derivatives contract you become interested in. Swaps, Credit Default Swaps, Futures, Options, Options on Futures, Leveraged Exchange Traded Funds, Inverse Leveraged Exchange Traded Funds, warrants, and more all have their own terminology. How to trade them in a simulation? It all depends on which financial product you really become interested in. "Q: A: Everyone that is short is paying interest to the owners of the shares that the short seller borrowed. Although this quells your conundrum, this is also unrelated to the term. Interest in this context is just the number. In the options market, each contract also has an open interest, which tells you how many of that contract is being held. For your sake, think of it as ""how many are interested"", but really its just a completely different context." Traditionally, dealers and broker-dealers were in contact with the actual producers of a product or issuers of a security, selling it at the exchange on their behalf.  Consumers would traditionally be on the buy side, of course. These days, anyone can enter the market on either side.  Even if you don't hold the security or product, you could sell it, and take on the risk of having to stock up on it by the delivery date in exchange for cash or other securities.  On the other side, if you can't hold the product or security you could still buy it, taking on the risk of having to dispose of it somehow by delivery in exchange for cash or other securities. In either case you (the sell-side) take on risk and provide products/securities/cash.  This is most commonly known as market making.  Modern literature coins the terms liquidity taker (buy-side) and liquidity provider (sell-side).  Even more accurately, risk management literature would use the terms risk-taker (sell-side) and risk spreader or risk reducer (buy side). This is quite illustrative in modern abstract markets.  Take a market that allows for no offsetting or hedging because the product in question is abstract or theoretical, e.g. weather trading, volatility trading, inflation trading, etc.  There's always one party trying to eliminate dependence on or correlation to the product (the risk reducer, buy-side) and the counterparty taking on their risk (sell-side). Typically there are several parties involved: (Sometimes one company plays multiple roles; for example AmEx is a network and an issuer.) When a merchant charges a card and the issuer approves it, money is transferred from the issuer to the acquirer to the merchant. This settlement process takes some time, but generally is completed within a day. Of course, most cardholders pay on a monthly basis. The issuer must use their own funds in the mean time. If the cardholder defaults, the issuer takes the loss. "Institutions and market makers tend to try and stay delta neutral, meaning that for every options contract they buy or write, they buy or sell the equivalent underlying asset. This, as a theory, is called max pain, which is more of an observation of this behavior by retail investors. This as a reality is called delta hedging done by market makers and institutional investors. The phenomenom is that many times a stock gets pinned to a very even number at a particular price on options expiration days (like 500.01 or 499.99 by closing bell). At options expiration dates, many options contracts are being closed (instutitions and market makers are typically on the other side of those trades, to keep liquidity), so for every one standard 100 share contract the market maker wrote, they bought 100 shares of the underlying asset, to remain delta neutral. When the contract closes (or get rid of the option) they sell that 100 shares of the underlying asset. At mass volume of options traded, this would cause noticeable downward pressure, similarly for other trades it would cause upward pressure as institutions close their short positions against options they had bought. The result is a pinned stock right above or below an expiration that previously had a lot of open interest. This tends to happen in more liquid stocks, than less liquid ones, to answer that question. As they have more options series and more strike prices. No, this would not be illegal, in the US attempting to ""mark the close"" is supposedly prohibited but this wouldn't count as it, the effect of derivatives on stock prices is far beyond the SEC's current enforcement regime :) although an active area of research" It's a good answer. I was alluding to cryptocurrency such as bitcoin which was a pretty genius invention (blockchain and mining) to solve the honesty problem (counterparty risk) you outlined when there's no trusted middleman to help keep people honest. Sounds like a dodgy cat though! A derivative is a financial asset (read: contract) whose value is determined by the value of some other asset. Talking about derivatives in general is impossible, options and FRAs (eg) are entirely different.   Is there any type of derivative you are particularly interested in? "Every one of those articles correctly point out that $3.7 trillion is **the size of a bond market**. Not one calls them a **""business worth $3.7 trillion.""**  The size of a market is not not the value of a business.  I guess even after all this you're still unable to grasp that.  His quote: ""The banks achieved this gigantic rip-off by secretly colluding to rig the public bids on municipal bonds, **a business worth $3.7 trillion**"".   Are you really too dumb to understand the difference between ""a business worth $3.7 trillion"" and the value of an entire market? The derivatives market is ""worth"" on the order of hundreds of trillions. Which businesses exactly are worth that much?  This is the type of ignorance that Taibbi articles relies upon to make them work. I'm done here since you see two numbers that are the same and conclude they mean the same thing."