Derivatives are one of the most complex instruments. The word ‘derivative’ comes from the verb ‘ to derive’. It indicates it has no independent value. A derivative is a contract whose value is derived from the value of another asset known as the underlying, which could be a share, a stock market index, an interest rate, a commodity, or a currency, the value of derivative also changes. Without an underlying, derivatives do not have any meaning. For example, the value of a gold futures contract derives from the value of the underlying asset, that is gold.

To understand the meaning of derivatives, let us take example of a commodity such as cotton, which is the raw material for the textile industry. It may so happen that the price of cotton arises before and after the harvest but falls at the time of harvest. The farmer, who is exposed to such price fluctuations, can eliminate this risk by selling his harvest at a future date by entering into a forward, or futures contract. This forward, or futures, contract takes place in the ‘derivatives’ market. The prices in the in the derivatives market are driven by the spot or cash market of the underlying asset, which is cotton in this example.

The market for financial derivatives has grown tremendously both in terms of variety of instruments and turnover. Derivatives can be futures, options, swaps, forwards, puts, calls, index-linked and so on.  in financial derivatives, the underlying includes treasuries, bonds, stocks, stock index, foreign exchange, and euro-dollar deposits.