Importance of Derivatives

The importance of derivatives are as follows:

  1. Reflect Perception of Market Participants: In a developed and organized market, the price of the derivatives will show the view of market participants about the future course of action for the market. It will also guide the price of the underlying. Towards the expiration date, the price of the derivatives and the price of the underlying tend to converge. Hence, derivatives help in price discovery.
  2. Helps to Transfer Risks: The derivatives also help transfer risk from one party to another.
  3. Higher Trading Volume: The derivatives are directly linked to their underlying cash market. With the help of derivatives, the cash market experiences higher volumes, which helps in improving the liquidity in the market.
  4. Controlled Environment: Derivatives market allows for speculative trade in a more controlled manner. In the absence of this market, speculation will take place in legal markets, making them more risky and harmful to the health of the markets and the economy.
  5. Attract Entrepreneurial: Derivatives market also helps in generating new entrepreneurial activities. This type of trading generally attracts qualified and ambitious people and helps create new products and markets.

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