Why are investments in derivative instruments risky ?

Investment in derivative instruments risky because the market values of derivative products may not move in the same direction or to the same extent as those of the underlying securities. In certain circumstances, derivative products may be rendered valueless or unredeemable and investors may not recover any amount of principal investment back. Derivatives trading involves several risks. Price volatility creates the main risk as market fluctuations lead to losses for investors. Derivatives also involve market risk, counterparty risk, and liquidity risk, especially in over-the-counter (OTC) contracts where default by the counterparty can result in losses. Their complexity makes valuation difficult and increases the risk of mispricing and inadequate risk assessment. Additionally, derivatives can amplify losses during volatile market conditions. Hence, without proper risk management and expertise, investments in derivative instruments can expose investors to significant financial risk.