[grania]

Yes, that helps somewhat. I'm going to read it over, slowly, at least three times today. I won't even look for errors, your numbers get the give-and-take across. It does sound like a bit of a Monopoly game, where I buy a derivative on say a hotel on Boardwalk according to a present value, but the price of that hotel fluctuates day to day, and I give or get money accordingly. That would really mess up the game, especially if people had the means to manipulate the value of a hotel on Boardwalk.

How could a derivative not be subjected to cheating? If I wanted to lower that spread on a Pats game, I'd start a well placed rumor that Tom Brady couldn't play in that game....(etc)

This really shouldn't be allowed; it does sound like gambling where insider knowledge and manipulation win the day.

[boomstick]

Rumors affect both the underlying instrument and the derivative. If there’s a rumor that a company is going to be taken over, the share price will jump. If there’s a rumor that a storm is coming, there will be a run on the grocery store. If there’s a rumor that Tom Brady won’t be playing, prices for tickets on StubHub may fall.

Derivatives allow proxy hedging for illiquid holdings. If I want to refinance my mortgage at current low rates, but due to liquidity or scheduling or whatnot I can’t, I can still trade some other interest rate product (like a bond future) so that if rates rise I’ll make money to make up for the higher rate I’ll pay on the mortgage. There will be some costs involved (transaction costs), and the profit/loss on the hedge won’t be exactly equal to the impact on my mortgage (basis risk), but if I size it appropriately the impact will at least be kind-of, sort-of, right-ish.