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Function of derivative market

What is a ‘derivative’? A derivative is a financial contract whose value is derived from or depends on the price of some underlying asset. Equivalently the value of a derivative changes when there is a change in the price of an underlying related asset.Risk Management-As derivative prices are related to the underlying spot market goods (assets), they can be used to reduce or increase the risk of owing the spot items. For example, buying the spot item and selling a futures contract or call option reduces the investor’s risk. If the goods price falls, the price of the futures or options contract will also fall. The investor can then repurchase the contract at the lower price, affecting a gain that can at least partially offset the loss on the spot item. 

Price discovery-Forward and futures markets are an important source of information about prices. Futures markets in particular are considered a primary means for determining the spot price of an asset. 

Operational advantages-Derivative markets offer several operational advantages, such as:
1. They entail lower transaction costs. This means that commission and other trading costs   lower for traders in these markets.
2. Derivative markets, particularly the futures and exchanges have greater liquidity than the spot markets.

Market efficiently-Spot markets for securities probably would be efficient even if there were no derivative markets. There are important linkages among spot and derivative prices. The ease and low cost of transacting in these markets facilitate the arbitrage trading and rapid price adjustments that quickly eradicate these opportunities. 

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