A derivative is a time-bound financial contract whose value is derived from an underlying asset like a stock, commodity, currency, or index. Derivatives are commonly used in trading to hedge risks or speculate on price movements—without having to own the asset directly.
Key characteristics of derivatives
- Value is dependent: A derivative has no standalone value; its worth is based on the performance of the underlying asset.
- Contractual in nature: It’s an agreement between two parties that sets a future price for buying or selling the underlying asset.
- Time-sensitive: Every derivative contract has an expiration date. Depending on the type, it can result in cash settlement or physical delivery.
Why are derivatives used?
Derivatives are used by traders and investors for multiple purposes:
- Hedging: To protect against price fluctuations.
- Speculation: To take advantage of expected price movements.
- Market access: To gain exposure to assets that may not be easily accessible.
Common types of derivatives
- Futures: Standardized contract to buy/sell at a future date at a predetermined price.
- Options: Gives the right, but not the obligation, to buy/sell an asset within a specified period.
- Forwards and Swaps: More complex and typically used in institutional trading.
Example – Using a futures contract
Imagine you're a farmer growing apples, expecting your harvest in 3 months.
To avoid price risk, you enter into a futures contract to sell apples at ₹100/kg after 3 months.
Scenario A: Market price falls to ₹80/kg
You still sell at ₹100/kg per the contract, avoiding a loss.
Scenario B: Market price rises to ₹120/kg
You still sell at ₹100/kg and miss out on extra profit, but you had price certainty.
This example illustrates how derivatives offer security in uncertain markets.
What If...
| Scenario | Explanation |
|---|
| I enter a futures contract and the market moves in my favor | You may gain from the price difference if you’re on the right side of the trade. |
| The market moves against me | You could face a loss. It’s essential to monitor margin requirements and expiry. |
| I don't understand the risks | Always understand contract terms before trading derivatives, as they involve leverage and volatility. |
Before trading derivatives on FYERS, ensure you understand margin obligations, expiry schedules, and the impact of the underlying asset's movement on your position.
Last updated: 28 Jun 2025