What a derivative is

This subject needs a warning on the first page, and it is SEBI's own, so chapter 10 can wait no longer than it has to. For now, the mechanics.

The definition

SEBI's, read on 1 October 2026:

Derivatives refers to the financial instruments which derive their value from an underlying security or financial instrument.

That is the whole category. A derivative is a contract, and its value comes from the price of something else — the underlying. Equity, an index, a commodity, a currency.

You are not buying the thing. You are buying an agreement about the thing.

Why that distinction matters

Three consequences follow immediately, and they are the three ways derivatives differ from everything else in this course.

There is a counterparty. A share is a claim on a company. A derivative is an agreement with another market participant. When you gain, somebody on the other side loses, and the reverse. Chapter 1 of the equity subject's share has no such symmetry — a company can make every shareholder better off at once. A derivatives contract cannot.

It expires. Shares last as long as the company. Every derivative has a date after which it does not exist. Being right about direction and wrong about timing is a complete loss in a way it never is with a share.

You can commit to far more than you put down. Chapter 5 is this, and it is where the damage comes from.

Why they exist

SEBI's own framing, from the study this subject relies on later:

Derivatives market assist in better price discovery, improve market liquidity and allow investors to manage their risks better.

Three genuine functions.

Hedging. A jeweller holding gold, an exporter owed dollars, a fund holding shares — each can offset a price risk they did not choose to take. This is what derivatives are for, and chapter 8 is about it.

Price discovery. A futures price aggregates views about where something will be, which is information the spot price alone does not carry.

Liquidity. More ways to express a view means more trading and tighter spreads in the underlying.

Those are real. SEBI's sentence does not stop there, and nor should this chapter:

However, with an explosion in index options trading on expiry day over time, concerns arose around investor protection & systemic stability.

Both halves are the regulator's. A category can be economically useful and still be where individuals lose the most money, and chapter 10 has the figures.

The two instruments

Almost everything an individual encounters is one of two.

A future is an obligation. Both sides must perform at expiry. Chapter 2.

An option is a right for one side and an obligation for the other. Chapter 3.

That asymmetry — right versus obligation — is the most important structural fact in the subject, and chapter 6 draws it as a picture.

Nearly zero sum, and then worse

A point worth making before any of the mechanics, because it frames everything.

A share can rise for everyone who holds it: the company earns more, and all owners benefit together. Chapter 2 of the equity subject's earnings growth is a source of return that comes from outside the market.

A derivatives contract has no such source. Every rupee gained by one side is lost by the other. Before costs, the segment is close to zero sum.

After costs it is negative sum for participants as a group — brokerage, exchange charges, taxes and the spread all leave the system. So for the population of traders taken together, the expected outcome is not zero. It is a loss equal to the costs.

That is arithmetic, not pessimism, and it is why chapter 10's figures look the way they do.

What this subject is for

Not to teach you to trade. Four things:

1. To understand what these instruments are, since they set prices and appear constantly.
2. To understand hedging, which is the legitimate use and the one most often conflated with speculation.
3. To make the risks precise — leverage, expiry, and the open-ended loss of a sold option.
4. To present SEBI's evidence on what happens to individuals who trade them, which is the most important chapter here.

The point

A derivative is a contract whose value comes from something else. It has a counterparty, so gains and losses are paired, and it expires. The economic functions are real — hedging, price discovery, liquidity — and the segment is close to zero sum before costs and negative sum after them.