What do derivatives derive their value from?

Derivatives are financial instruments whose value is directly linked to the price movements of an underlying asset. This underlying asset can be a commodity, stock, bond, currency, or any other financial instrument. The primary purpose of derivatives is to hedge risk or to speculate on future price movements of these assets. By deriving their value from these underlying assets, derivatives allow investors and traders to gain exposure to price changes without needing to own the actual asset.

In financial markets, understanding the relationship between derivatives and their underlying assets is crucial because it determines the behavior and pricing of these financial products. For instance, options contracts and futures contracts are common types of derivatives that explicitly stipulate they are based on the performance and price fluctuations of their respective underlying assets. This foundational principle underpins the use of derivatives in various trading and risk management strategies.