How can derivatives aid in distressed investing?

Derivatives play a significant role in distressed investing primarily through their ability to act as hedging instruments. When investors engage in distressed investing, they often encounter high levels of uncertainty and risk associated with the underlying assets, such as bankrupt companies or those facing financial difficulties. Using derivatives allows investors to manage and mitigate these risks effectively.

By employing derivatives such as options and futures, distressed investors can protect their positions against adverse movements in stock prices or other financial metrics. For instance, if an investor holds equity in a troubled company, they might purchase put options on that stock, which gives them the right to sell the stock at a predetermined price. This strategy can help to limit potential losses if the company's situation worsens.

Overall, the use of derivatives enhances the flexibility and risk management capabilities of distressed investors, allowing them to create more favorable outcomes even in challenging circumstances. This is why the choice related to hedging against risks is the most relevant and accurate in the context of utilizing derivatives in distressed investing.