Concept of Derivative

Any financial instrument that is derived from an underlying asset like index, event, value or condition is known as a derivative. Derivative traders enter into an agreement to exchange assets or cash over time based on the underlying asset.

Derivatives are highly leveraged - a small movement in the value of underlying asset can lead to a large difference in value of the derivative.

Investors can use derivatives to speculate and earn profit if the value of the underlying asset moves in the expected way. Else wise, traders can use derivatives to mitigate or hedge the risk in the underlying, by entering into such a derivative contract whose value moves in the opposite direction to their underlying position and cancels either part or all of it.

Derivatives are broadly categorized depending on:

• Relationship of the underlying asset with the derivative

• Type of underlying

• Market in which they trade