Derivatives is a product whose value is derived from the value of one or more basic variables, called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. For example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by that date. Such a transaction is an example of a derivative. The price of this derivative is driven by the spot price of wheat which is the underlying.
The Securities Contracts (Regulation) Act. 1956 (SC(R)A) of India defines derivative as
- A security derived from the debt instrument, share, loan whether secured or un-secured, risk instrument or contract for differences or any other form of security.
- A contract which derives its value from the prices or index of prices of underlying securities.
Derivatives are securities under The Securities Contracts (Regulation) Act and hence the trading of derivatives is governed by the regulatory framework under the above said Act.
EMERGENCE OF DERIVATIVE PRODUCTS: Derivative products initially emerged as hedging devices against fluctuations in commodity prices, and commodity linked derivatives remained the sole form of such products for almost three hundred years. Financial derivatives came into spotlight in the post – 1970 period due to growing instability in the financial markets. However, since their emergence, these products have become very popular and by 1990s. they accounted for about two thirds of total transactions in derivative products. In recent years, the market for financial derivatives has grown tremendously in terms of variety of instruments available, their complexity and also turnover. In the class of equity derivatives the w’orld over, futures and options on stock indices have gained more popularity than on individual stocks, especially among institutional investors, who are major users of index-linked derivatives. Even small investors find these useful due to high correlation of the popular indexes with various portfolios and ease of use.
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