NISM-Series-VIII: Equity Derivatives · Basics of Derivatives

Meaning and Features of Derivatives for NISM Equity Derivatives

Updated 11 October 2026 · Fact-checked

A derivative is a contract whose value is derived from an underlying asset such as a share, index, commodity, currency or interest rate. Under the SCRA, 1956, derivatives are treated as securities. To answer exam questions, identify the underlying, the contract type and the feature being tested.

Understand Meaning and Features of Derivatives

A derivative is a financial contract. It has no value of its own. Its value depends on, or is derived from, something else called the underlying.

The underlying can be a share, a stock index such as Nifty 50, a commodity, a currency, an interest rate or even another derivative. If the price of the underlying moves, the price of the derivative moves with it. Example: a Nifty futures contract rises and falls with the Nifty index.

Key features you must know:
- Value linked to an underlying. The contract is a promise about the future price of something else.
- Contract between two parties. One party gains and the other loses on price moves.
- Future settlement. Settlement happens on a future date, or the contract is settled on expiry.
- Leverage. You pay a small amount (margin or premium) to get exposure to a large value. Gains and losses are both magnified.
- Used for hedging, speculation and arbitrage. Hedgers reduce risk, speculators take risk for profit, arbitrageurs exploit price gaps between markets.

Legal definition: the Securities Contracts (Regulation) Act, 1956 (SCRA) includes derivatives within the meaning of securities. It describes a derivative as a contract whose value is derived from the prices or index of prices of underlying securities. It also covers contracts that derive value from other underlying such as commodities and other items notified. Because derivatives are securities, they can be traded only on recognised stock exchanges under SEBI's oversight, and contracts that are not permitted are not valid.

Exam trap: a derivative is not the underlying itself. Buying a share is a cash market deal. Buying a futures contract on that share is a derivative deal.

Key formulas to remember

Core definition: Derivative value = f(price of underlying); The derivative has no independent value. It depends on the underlying.
Legal status: Derivative ∈ 'securities' under SCRA, 1956; Derivatives are securities in law, so they are regulated by SEBI and traded on recognised exchanges.
Types of underlying: Share | Index | Commodity | Currency | Interest rate | Other derivative; Equity derivatives use shares or indices as the underlying.
Uses of derivatives: Hedging | Speculation | Arbitrage; These are the three standard purposes. Match each to the participant type.
Leverage: Exposure = contract value; Outlay = margin or premium (much smaller); Small outlay controls a large value. This magnifies both profit and loss.

How to solve Meaning and Features of Derivatives questions

Use this method for any definition or feature question on derivatives.

1Read the question and find the key word: underlying, value, leverage, settlement, hedging or SCRA.
2Ask: is the item a contract whose value depends on something else? If yes, it is a derivative.
3Identify the underlying in the question (share, index, commodity, currency, interest rate).
4Match the feature described to its name: leverage, future settlement, linked value, or risk transfer.
5For legal questions, recall that SCRA treats derivatives as securities and requires trading on recognised exchanges.
6Check each option for words like 'always' or 'no risk'. Reject statements that overstate.
7Pick the option that matches the definition most precisely.

Quickest way: Three-question filter

When to use it: Use when you have under a minute for a definition or feature MCQ.

Does value depend on an underlying? If not, it is not a derivative.
Is the option about law? Think 'securities under SCRA'.
Is the option about purpose? Pick hedging, speculation or arbitrage by who is acting and why.

Common mistakes in Meaning and Features of Derivatives

Treating the underlying as the derivative, for example calling a share a derivative.
Students mix the asset with the contract written on it.
Fix: Remember: the share is the underlying. The futures or option on the share is the derivative.
Saying derivatives reduce risk for everyone.
Hedging is stressed so much that speculation is forgotten.
Fix: Derivatives can reduce risk (hedgers) or add risk (speculators). Leverage magnifies losses too.
Thinking derivatives are outside the definition of securities.
They look different from shares and bonds.
Fix: SCRA, 1956 includes derivatives in the definition of securities.
Assuming the underlying must be a share.
The exam is about equity derivatives, so the focus narrows.
Fix: Underlying can also be an index, commodity, currency or interest rate. Equity derivatives use shares or indices.
Confusing leverage with a free gain.
A small margin looks like a small risk.
Fix: Exposure is the full contract value. Losses can exceed the margin paid.

Worked examples

Example 1

Which of the following is a derivative? (a) 100 shares of a company bought in the cash market (b) A futures contract on Nifty 50 (c) A fixed deposit with a bank (d) A company's equity share capital

Show the solution

A derivative must derive its value from an underlying.
Option (a) is the share itself. It is an underlying, not a derivative.
Option (b) is a contract whose value depends on the Nifty 50 index. This fits the definition.
Options (c) and (d) have no underlying asset linkage in this sense.

Answer: (b) A futures contract on Nifty 50.

Example 2

Under the Securities Contracts (Regulation) Act, 1956, how are derivatives treated? (a) As commodities only (b) As securities (c) As unregulated private contracts (d) As bank deposits

Show the solution

Recall the legal position: SCRA includes derivatives in the definition of securities.
This brings them under SEBI's oversight and recognised exchange trading.
Option (a) is wrong because derivatives can have many underlyings.
Option (c) is wrong because the law regulates them.
Option (d) has no basis in SCRA.

Answer: (b) As securities.

Exam tips

Expect direct definition questions. Learn the one-line definition word for word in your own words.
Watch for options with absolute words like 'always' or 'never'. They are often traps.
Know the three uses (hedging, speculation, arbitrage) and who does each.
Remember SCRA treats derivatives as securities. This is a common one-mark question.
NISM Series VIII has negative marking of 25% of the marks of a question, so skip options you cannot reason out.

Practice questions from Basics of Derivatives

Meaning and Features of Derivatives in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

CS ExecutiveDerivatives, Options and Prohibited Contracts

Meaning and Features of Derivatives: frequently asked questions

What is a derivative contract in NISM?

It is a contract whose value is derived from an underlying asset such as a share, index, commodity, currency or interest rate. It has no value of its own. Its price moves with the underlying.

How does SCRA define a derivative?

SCRA, 1956 includes derivatives in the definition of securities. It describes them as contracts deriving value from the prices or index of prices of underlying securities, along with other notified underlying. This makes them regulated instruments.

What are the main features of derivatives?

Value linked to an underlying, a contract between two parties, settlement at a future date, leverage, and use for hedging, speculation and arbitrage. Leverage magnifies both gains and losses.

What can be the underlying of a derivative?

It can be a share, a stock index, a commodity, a currency, an interest rate or another derivative. In Series VIII, the focus is on shares and indices.