Underlying

A derivative is a contract about something else. That something else is the underlying.

The word does two jobs in the workbook, and they are worth separating:

• The underlying instrument is the index or stock on which the contract is written — Nifty 50, or a single company's share.
• The underlying price (or underlying value) is the spot price: what that instrument is trading at in the cash market right now.

Every other number on a contract specification — the contract size, the tick, the settlement price, the margin — is derived from those two. A derivative has no independent existence. When the underlying goes to zero, so does the contract.

The exchange writes a specification around the underlying and fixes everything except the price. For an index futures contract that means the instrument type, the underlying asset, the expiry date, the lot size and the tick.

The contract size is the lever that connects a few index points to real money. SEBI's current stipulation: a derivative contract must have a value of not less than Rs 15 lakh at the time of its introduction, with the lot size fixed so that the contract value on the review date falls between Rs 15 lakh and Rs 20 lakh. The previous band, set in 2015, was Rs 5 lakh to Rs 10 lakh — and the workbook notes that broad market values had risen roughly threefold in the interval, which is why the band was moved.

The relationship between the underlying price and the derivative price is the whole of derivatives pricing:

• basis is the gap between them — on NISM's convention, spot minus futures.
• convergence is the guarantee that the gap closes to zero at expiry.
• Everything in between is cost-of-carry and expectation.

Contract value = Lot size × Price

Basis (NISM convention) = Spot price − Futures price

At expiry: Futures price = Underlying spot price, so Basis = 0

SEBI's contract-size rule:

Contract value at introduction ≥ Rs 15 lakh
Lot size set so value on review date lies in Rs 15 lakh – Rs 20 lakh

From a live Nifty futures quote on 3 October 2025:

At a lot size of 65:

Contract value = 65 × 24,894.25 = Rs 16,18,126.25

The basis, on the NISM convention:

Basis = Spot − Futures = 24,894.25 − 25,006.60 = −112.35

Negative, because the futures trade above the spot — a contango market. In money, that gap is worth

112.35 × 65 = Rs 7,302.75 per contract

and by the close on 28 October it will be zero, whatever the index does, because the contract settles at the underlying cash price. A trader long spot and short futures at those levels pockets that Rs 7,302.75 for holding both to expiry, less funding.

A caution on the arithmetic. Chapter 15 says the contract value is the lot size multiplied by the closing futures price, but its own computation uses the underlying value of 24,894.25 to reach Rs 16,18,126.25. Taken at the closing futures price of 25,006.60, the same lot is worth Rs 16,25,429. The workbook contradicts itself inside one sentence; both numbers appear above so you recognise either in a question.

Chapter 15 (Introduction to Forwards and Futures) defines the underlying instrument and underlying price on a live contract specification and works the contract value; Chapter 13 introduces the underlying as the thing every derivative derives from. Expect a contract-value computation and a definition question separating the underlying instrument from the underlying price.

• Underlying price means the spot price, not the futures price. They are two different numbers on the same screen, and the workbook prints both.
• Chapter 15 contradicts itself on which price enters the contract value — it says futures price and computes with the underlying value. State the basis you used.
• NISM defines basis as spot minus futures. Futures above spot gives a negative basis. The opposite convention is common elsewhere and wrong here.
• Lot sizes change. The Rs 15–20 lakh band replaced the Rs 5–10 lakh band set in 2015, so an old lot size in a question is a deliberate trap.
• The underlying of an index derivative cannot be delivered, which is why index contracts are cash settled.
• One underlying, many contracts. Near, next and far month futures plus a whole option chain all reference the same spot number.