What does a derivatives overlay primarily help manage?

A derivatives overlay is primarily used to manage market risk. This strategy involves using derivatives, such as options and futures, in conjunction with the underlying portfolio to hedge against adverse movements in the market. By employing a derivatives overlay, an investor can adjust their exposure to various risk factors, such as stock price volatility or interest rate changes, without making changes to the underlying assets in the portfolio.

The use of derivatives allows for more flexibility in risk management compared to adjusting the underlying securities directly. For instance, if an investor anticipates a downturn in the market, they can use derivatives to offset potential losses in their portfolio, effectively managing their overall market exposure. This dynamic approach allows funds to remain invested while mitigating risks associated with unfavorable market movements, enhancing the overall risk-return profile.

While managing duration is essential for fixed-income securities and liquidity is crucial for ensuring that an investor can meet their short-term obligations, these are not the primary focus of a derivatives overlay strategy. Structural risks are often related to the specific composition of a portfolio, which might not be directly addressed by the techniques associated with a derivatives overlay. Therefore, the most accurate answer regarding the primary purpose of a derivatives overlay is its role in managing market risk.