Let's look at the two primary functions of financial derivatives. These versatile instruments can be strategically utilized to either create new exposures or to manage existing ones. Essentially, they serve two pivotal roles, speculation and hedging.

Let's delve a bit deeper into each of those functions, beginning with hedging. Hedging is fundamentally about risk management. Think of it as a form of insurance. It's a strategy used to offset potential losses in an investment by taking an opposite position in a related derivative. The goal here is to balance the scales, ensuring that any adverse price movements in the underlying assets are counterbalanced by gains from the derivative position.

For instance, in our WTI forward contract scenario, imagine a trader who is part of an oil refining company's procurement team. This company regularly purchases oil to convert into products like gasoline and jet fuel. If the expectation is that oil prices will climb in the near future, securing a forward contract to buy oil at today's price for delivery in three months time acts as a hedge. This move locks in the cost protecting the company from the impact of rising prices.

On the flip side, we have speculation. Speculation is all about the pursuit of profit through calculated risk. Speculators are the risk takers of the financial world engaging in transactions based on anticipated market movements to earn returns. This involves buying or selling derivatives with the expectation of a favorable shift in value. Returning to our example of the WTI Forward contract, a macro investor predicting an upswing in oil prices over the next quarter might choose to go long an oil forward contract agreeing to buy oil at a fixed price through that forward contract. This speculative move isn't about reducing exposure, but using the traders' insights to turn a profit. So in summary, derivatives are dual natured. They can be powerful shields against market volatility or tools wielded in the pursuit of financial gain.