What is the role of derivatives in risk management?

Derivatives are commonly used in risk management as a way to reduce or hedge against various types of risk. For example, a company that relies heavily on a particular commodity may use futures contracts to lock in a certain price for that commodity, reducing the risk of price fluctuations. Similarly, investors may use options contracts to protect against potential losses in their portfolio, or to generate income from the premiums they receive by selling options.

In addition to hedging, derivatives can also be used to speculate on market movements, which can increase risk. This is why it is important for market participants to carefully evaluate their risk tolerance and financial situation before engaging in derivative trading. However, when used appropriately, derivatives can be a valuable tool for managing risk and achieving investment objectives.