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Derivative contracts are of different types. The most common ones are forwards, futures, options and swaps. Derivative Market Participants who trade in the derivatives market can be classified under the following three broad categories: hedgers, speculators, and arbitragers.
Hedgers: The farmerís example that we discussed about was a case of hedging. Hedgers face risk associated with the price of an asset. They use the futures or options markets to reduce or eliminate this risk.
Speculators: Speculators are participants who wish to bet on future movements in the price of an asset. Futures and options contracts can give them leverage; that is, by putting in small amounts of money upfront, they can take large positions on the market. As a result of this leveraged speculative position, they increase the potential for large gains as well as large losses.
Arbitragers: Arbitragers work at making profits by taking advantage of discrepancy between prices of the same product across different markets. If, for example, they see the futures price of an asset getting out of line with the cash price, they would take offsetting positions in the two markets to lock in the profit.
Whether the underlying asset is a commodity or a financial asset, derivatives market performs a number of economic functions.
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