What's the difference between an underlying asset and a derivative contract in trading?
Understanding the difference between an underlying asset and a derivative contract is essential for any trader or investor participating in F&O markets. One provides the value; the other is an agreement based on it.
What is an underlying asset?
The underlying asset is the actual financial instrument that a derivative gets its value from. It can be:
- A stock (e.g., Reliance Industries)
- An index (e.g., NIFTY 50)
- A currency pair (e.g., USDINR)
- A commodity (e.g., Gold)
These are traded directly in the cash or spot market.
What is a derivative contract?
A derivative is a financial contract whose value depends on the price movement of an underlying asset. It allows you to speculate on or hedge against future price changes without owning the asset directly.
Types of derivative contracts include:
- Futures: Agreement to buy/sell at a future date at a set price.
- Options: Right (but not obligation) to buy/sell the asset at a specific price within a set time.
Example
Let’s say you're trading NIFTY Futures:
- NIFTY 50 is the underlying index.
- The NIFTY Futures contract is the derivative instrument derived from that index’s price.
If the NIFTY index rises, the futures contract typically gains value accordingly.
What If...
| Scenario | Explanation |
|---|
| I trade a futures contract | You're trading a derivative based on an underlying like a stock or index. |
| I buy a stock directly | You're dealing with the underlying asset, not a derivative. |
| The underlying doesn’t move | The derivative’s value may remain stable or decay (especially for options). |
In derivatives, always know what the underlying asset is. Its price movement directly affects the profitability of your position in the contract.
Last updated: 28 Jun 2025
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