How Do Financial Derivatives like Options and Futures Impact the Liquidity of Their Underlying Assets?

Financial derivatives like options and futures can significantly increase the liquidity of their underlying assets. They do this by providing additional avenues for speculation and hedging, which attracts more traders to the market.

This increased trading activity translates into more buyers and sellers for the underlying asset, leading to tighter bid-ask spreads and greater market depth. For example, a highly liquid options market for a stock will often lead to a more liquid market for the stock itself, as options traders will frequently buy or sell the underlying stock to hedge their positions.