Let's turn back to our fundamental concept that a derivative is essentially a financial contract, the value of which is linked to or derived from an underlying asset. Let's delve into this concept with an example, which also illuminates the benefits tied to such a financial instrument.

Consider an example of a forward contract where a trader has secured a deal to purchase 10,000 barrels of oil. Let's say it's a particular type of oil called Western Texas Intermediate, or WTI crude oil with a settlement date three months from now. The price is set at $76.50 per barrel. The relationship between the contract's value and the underlying oil price is a continuous one. Throughout the life of the contract over the next three months here, but it becomes particularly clear as we approach the contract's expiry date. Let's consider two possible outcomes.

In the first scenario, the market price of oil rises to $80 a barrel. Here our trader stands to gain because they've locked in a purchase price of $76 and 50 cents, which is now $3.50 less than the market rate. And what about the value of the entire forward contract? It's increased by $35,000 calculated by multiplying the 10,000 barrels in the contract by the $3.50 price advantage per barrel. Conversely, in a second scenario, the market price shifts in the opposite direction. With the price of oil dropping to $73 per barrel, despite the market dip, our trader is contracted to proceed with the purchase at the contracted price of $76.50 which is now $3 50 above the market rate. This results in a contract value of minus $35,000, which comes from the 10,000 barrels in the contract now being purchased at $3.50 above the market price. These scenarios illustrate how movements in the underlying assets price directly affect the value of a forward contract. In our first scenario, the trader benefits from rising oil prices without the need to physically possess the oil itself, but in a second loses from the price declining. This is one of the key characteristics that make derivatives so appealing. They provide the ability to hedge against or speculate on the price movements of an underlying asset without the necessity of holding the asset itself. This feature can lead to significant strategic advantages in trading and risk management.