What are the uses of derivatives?

Derivatives are used for a variety of purposes in financial markets, including risk management, speculation, and arbitrage.

One of the primary uses of derivatives is as a risk management tool. Financial institutions, companies, and investors can use derivatives to hedge against potential losses from fluctuations in asset prices, interest rates, currency exchange rates, and other market variables. By using derivatives to hedge against these risks, investors can limit their exposure to potential losses while still maintaining exposure to the underlying asset.

Derivatives are also used for speculation, or taking on risk in the hopes of earning a profit. Traders can use derivatives to make bets on the future direction of asset prices, interest rates, and other market variables. For example, an investor may purchase a call option on a stock if they believe that the stock price will increase, or they may purchase a put option if they believe the stock price will decrease.

Finally, derivatives can be used for arbitrage, or taking advantage of price discrepancies between different markets. For example, a trader may buy a futures contract on an asset in one market and sell a similar futures contract on the same asset in another market if they believe that the prices are out of sync. This can lead to profits if the prices eventually converge.