Derivatives market

Derivatives market

The derivative market is a vibrant and intricate financial environment essential to contemporary economies. This market provides investors with a wide range of chances for speculating, risk management, and portfolio diversification because of its assortment of contracts produced from underlying assets, including stocks, commodities, and currencies. But managing the complexities of derivatives calls for a thorough knowledge of their workings, dangers, and benefits. 

What is a derivative market? 

A financial market where derivative instruments are traded is the derivatives market. Financial instruments or contracts known as derivatives derive their value from an underlying asset, like currencies, stocks, commodities, bonds, or market indices. Options, futures, forwards, and swaps are examples of common derivatives. 

Investors and traders can purchase, sell, or speculate on these derivative instruments in the derivatives market. This market has many uses, including managing financial risks, hedging against price swings, and gambling on market trends. It is essential for speeding up price discovery and improving market liquidity. 

Understanding the derivative market 

The buying and selling of derivative contracts drive the operation of the derivative market. These contracts have an underlying asset—such as stocks, commodities, or currencies—that provide value.  

To make predictions of price fluctuations of the underlying asset, market participants can enter into derivative contracts like options or futures. The underlying asset’s price, the amount of time till expiration, and market volatility are some variables that affect how much a derivative is worth.  

Investors can use derivatives to take on risky positions with leverage, protect themselves from price risks, or pursue arbitrage opportunities. Derivative contracts may be settled by physically delivering the underlying asset or in cash. 

Importance of the derivative market 

The derivative market is very important to market participants and greatly impacts the global financial system. Utilising derivatives enables efficient risk management and hedging. Derivatives are a tool that participants can utilise to limit possible losses brought on by changes in asset values, interest rates, or exchange rates. These aid in portfolio stabilisation and offer defence against unfavourable market fluctuations.  

Opportunities for speculation and arbitrage exist thanks to derivatives. Market price differences can be exploited by traders, resulting in more liquidity and effective price discovery. Even without direct ownership, investors in the derivative market can get exposure to various asset types and marketplaces, creating options for diversification and giving opportunities to make investments that might not otherwise be available. By permitting risk transfer between parties, derivatives aid in allocating capital effectively, encourage market effectiveness and raise total economic output. 

Benefits of the derivative market 

The following are the benefits of the derivative market: 

  • For market players, the derivative market has several benefits. First off, it offers a method for hedging and controlling risks. Market participants can protect their portfolios and stabilise their financial positions by using derivatives to offset any losses resulting from price changes in the underlying assets. 
  • The derivatives market facilitates price discovery. Derivative contracts’ prices reflect market expectations and sentiments because they are based on underlying assets, and this information is helpful for investors in determining the market’s future course. 
  • Market liquidity is improved via the derivatives market. It draws a wide spectrum of market players by offering a platform for trading derivative instruments, which boosts trading activity, narrows bid-ask spreads, and increases market liquidity overall. 
  • Leveraging is possible on the derivatives market, which increases investment returns. Market participants can obtain more control over the underlying assets with comparatively minimal investments, potentially boosting their profits. 
  • The derivatives market encourages creativity and adaptability. It enables market participants to handle a wide range of risks and strategies by permitting the production of specialised derivative contracts catered to particular needs. 

Example of a derivative market 

The Chicago Mercantile Exchange, or CME Group, is an example of a derivative market. One of the biggest and most well-known derivatives exchanges worldwide is the CME Group. It offers a comprehensive range of derivative products, including futures contracts and options on various asset classes, such as commodities, currencies, interest rates, and equity indices.  

For instance, the CME Group offers futures contracts for goods, including agricultural commodities, gold, and crude oil. These derivative contracts allow market participants to bet on price changes, protect themselves against risks, and transact in a controlled and open environment. 

Frequently Asked Questions

A derivative market has pros in terms of greater liquidity, price discovery, and options for risk management. It enables investors to diversify their investments and insure against price changes. The cons of the derivative market include the potential for significant risk and volatility, complexity, and the potential for speculative trading to cause market instability. If employed incorrectly and without sufficient understanding, derivatives can also magnify losses. 

The underlying assets or benchmark determines the value of financial contracts referred to as derivatives. Options, futures, swaps, and forward contracts are some of them. With the aid of derivatives, investors can speculate on or protect themselves from changes in price or other aspects of the underlying asset’s variables. 

The derivatives market is inherently risky and complex, and investors need to be aware of the potential risks involved. One of the key risks of the derivatives market is market risk, which refers to the possibility that the value of the derivative will decline due to changes in market conditions. This risk is particularly acute for investors who use leverage or margin to invest in derivatives. 

Another derivatives market risk is counterparty risk, which arises when one party in a derivative transaction fails to fulfil its obligations. This risk is particularly relevant for over-the-counter, or OTC derivatives, which are not traded on exchanges and lack the same regulation and transparency level. 

Finally, there are legal and regulatory risks associated with the derivatives market. The regulations governing derivatives vary widely by country, and investors need to know the legal and regulatory framework in each jurisdiction where they invest. 

The stock market’s four main types of derivatives are options, futures contracts, forward contracts, and swaps. 

Shareholders are granted the right to profit from a company’s success and vote in its management through the ownership of its stock. Derivatives o the other and are financial contracts whose value is derived from an underlying asset, such as stocks. They can be employed for arbitrage, hedging, or speculating. 

Related Terms

    Read the Latest Market Journal

    Deciphering the Updates: Understanding the latest CPF Changes

    Published on Mar 5, 2024 17 

    The latest changes to the Central Provident Fund (CPF), as unveiled in the 2024 Budget...

    Weekly Updates 4/3/24 – 8/3/24

    Published on Mar 4, 2024 23 

    This weekly update is designed to help you stay informed and relate economic and company...

    Weekly Updates 26/2/24 – 1/3/24

    Published on Feb 28, 2024 62 

    This weekly update is designed to help you stay informed and relate economic and company...

    All-in-One Guide to Investing in China via ETFs

    Published on Feb 27, 2024 441 

    Start trading on POEMS! Open a free account here! Why China? In the vast landscape...

    Navigating the Post-Inflation Landscape in 2024: Top 10 US Markets Key Events to Look out for

    Published on Feb 23, 2024 452 

    Start trading on POEMS! Open a free account here! In 2023, the United States experienced...

    From Boom to Bust: Lessons from the Barings Bank Collapse

    Published on Feb 23, 2024 62 

    Barings Bank was one of the oldest merchant banks in England with a long history...

    Decoding FX CFD 2.0

    Published on Feb 20, 2024 70 

    This article is aimed at availing information and knowledge essential to intermediate forex traders. It...

    Weekly Updates 19/2/24 – 23/2/24

    Published on Feb 19, 2024 89 

    This weekly update is designed to help you stay informed and relate economic and company...

    Contact us to Open an Account

    Need Assistance? Share your Details and we’ll get back to you


    This material is provided by Phillip Capital Management (S) Ltd (“PCM”) for general information only and does not constitute a recommendation, an offer to sell, or a solicitation of any offer to invest in any of the exchange-traded fund (“ETF”) or the unit trust (“Products”) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. You should read the Prospectus and the accompanying Product Highlights Sheet (“PHS”) for key features, key risks and other important information of the Products and obtain advice from a financial adviser (“FA“) pursuant to a separate engagement before making a commitment to invest in the Products. In the event that you choose not to obtain advice from a FA, you should assess whether the Products are suitable for you before proceeding to invest. A copy of the Prospectus and PHS are available from PCM, any of its Participating Dealers (“PDs“) for the ETF, or any of its authorised distributors for the unit trust managed by PCM.  

    An ETF is not like a typical unit trust as the units of the ETF (the “Units“) are to be listed and traded like any share on the Singapore Exchange Securities Trading Limited (“SGX-ST”). Listing on the SGX-ST does not guarantee a liquid market for the Units which may be traded at prices above or below its NAV or may be suspended or delisted. Investors may buy or sell the Units on SGX-ST when it is listed. Investors cannot create or redeem Units directly with PCM and have no rights to request PCM to redeem or purchase their Units. Creation and redemption of Units are through PDs if investors are clients of the PDs, who have no obligation to agree to create or redeem Units on behalf of any investor and may impose terms and conditions in connection with such creation or redemption orders. Please refer to the Prospectus of the ETF for more details.  

    Investments are subject to investment risks including the possible loss of the principal amount invested. The purchase of a unit in a fund is not the same as placing your money on deposit with a bank or deposit-taking company. There is no guarantee as to the amount of capital invested or return received. The value of the units and the income accruing to the units may fall or rise. Past performance is not necessarily indicative of the future or likely performance of the Products. There can be no assurance that investment objectives will be achieved.  

    Where applicable, fund(s) may invest in financial derivatives and/or participate in securities lending and repurchase transactions for the purpose of hedging and/or efficient portfolio management, subject to the relevant regulatory requirements. PCM reserves the discretion to determine if currency exposure should be hedged actively, passively or not at all, in the best interest of the Products.  

    The regular dividend distributions, out of either income and/or capital, are not guaranteed and subject to PCM’s discretion. Past payout yields and payments do not represent future payout yields and payments. Such dividend distributions will reduce the available capital for reinvestment and may result in an immediate decrease in the net asset value (“NAV”) of the Products. Please refer to <> for more information in relation to the dividend distributions.  

    The information provided herein may be obtained or compiled from public and/or third party sources that PCM has no reason to believe are unreliable. Any opinion or view herein is an expression of belief of the individual author or the indicated source (as applicable) only. PCM makes no representation or warranty that such information is accurate, complete, verified or should be relied upon as such. The information does not constitute, and should not be used as a substitute for tax, legal or investment advice.  

    The information herein are not for any person in any jurisdiction or country where such distribution or availability for use would contravene any applicable law or regulation or would subject PCM to any registration or licensing requirement in such jurisdiction or country. The Products is not offered to U.S. Persons. PhillipCapital Group of Companies, including PCM, their affiliates and/or their officers, directors and/or employees may own or have positions in the Products. Any member of the PhillipCapital Group of Companies may have acted upon or used the information, analyses and opinions herein before they have been published. 

    This advertisement has not been reviewed by the Monetary Authority of Singapore.  


    Phillip Capital Management (S) Ltd (Co. Reg. No. 199905233W)  
    250 North Bridge Road #06-00, Raffles City Tower ,Singapore 179101 
    Tel: (65) 6230 8133 Fax: (65) 65383066