What is a Derivative?
A derivative is a contract whose value is derived from the price of another asset — the underlying. The underlying can be a stock, an index, a commodity (gold, ...
Derivative Contract
A derivative is a contract whose value is derived from the price of another asset — the underlying. The underlying can be a stock, an index, a commodity (gold, oil, wheat), a currency, an interest rate or a bond.
Derivatives let participants take a financial position on an asset without owning it outright. The four main product families are forwards, futures, options and swaps. Each is a promise about a future price, settled on a specific date. Because the contract value tracks the underlying, a derivative can magnify gains or losses (leverage), hedge an existing exposure, or let an arbitrageur lock in a risk-free price difference between two markets. Derivatives are traded either on an organised exchange (standardised, cleared, margined) or over-the-counter (customised, bilateral).
The ticket's value depends on the concert — the ticket is the derivative, the concert is the underlying
A farmer locks in a price today for wheat delivered in 3 months — a forward contract
Every derivative is an IOU between a buyer and a seller dated for a future day
Put down 10% margin to control 100% exposure — small move, big P&L
Spot vs Derivative — Same View, Different Exposure
Three investors hold the same bullish view on Reliance at ₹2,400. Each chooses a different vehicle. At ₹2,550 expiry, here's how their outcomes diverge.
| Vehicle | Capital Put In | P&L at ₹2,550 | Return on Capital | Risk if Wrong |
|---|---|---|---|---|
| Buy 250 shares (spot) | ₹6,00,000 | +₹37,500 | +6% | Limited to price fall |
| 1 Futures lot (250) | ₹90,000 margin | +₹37,500 | +41% | Losses magnified — margin calls |
| 1 Call option ₹2,400 strike | ₹13,750 premium | +₹23,750 | +173% | Limited to ₹13,750 lost |
| Sell Put ₹2,400 strike | ₹85,000 margin | +₹13,750 | +16% | Losses below breakeven |
What Makes This Important
Frequently Asked Questions
Yes. The Securities Contract Regulation Act (SCRA) was amended in 1999 to include "derivatives" in the definition of "securities", which brought them under SEBI's regulatory framework.
🧠 Quick Quiz
3 questions to check your understanding