A derivative is a financial security with a value that is reliant upon, or derived from, an underlying asset or group of assets.  

In a forward contract, two parties agree to do a trade at some future date, at a stated price and quantity. No money changes hands at the time the deal is signed.

Forward contracting is very valuable in hedging and speculation. If a speculator has information or analysis which forecasts an upturn in a price, then he can go long on the forward market instead of the cash market. The speculator would go long on the forward, wait for the price to rise, and then take a reversing transaction making a profit.

Forward markets worldwide are afflicted by several problems:
(a) Lack of centralisation of trading,
(b) Illiquidity, and
(c) Counterparty risk.

There are two types of derivatives instruments traded on Exchanges; namely Futures and Options:

 Futures: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price.
 Options: An Option is a contract which gives the right, but not an obligation, to buy or sell the underlying at a stated date and at a stated price. While a buyer of an option pays the premium and buys the right to exercise his option, the writer of an option is the one who receives
the option premium and therefore obliged to sell/buy the asset if the buyer exercises it on him.

Options are of two types – Calls and Puts options:
“Calls” give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date.
“Puts” give the buyer the right, but not the obligation to sell a given quantity of underlying asset at a given price on or before a given future date. All the options contracts are settled in cash.
Further the Options are classified based on type of exercise. At present the Exercise style can be European or American.

American Option – American options are options contracts that can be exercised at any time upto the expiration date. Options on individual securities available at NSE are American type of options.

European Options – European options are options that can be exercised only on the expiration date. All index options traded at NSE are European Options.

Open interest refers to the number of outstanding contracts in the exchange market.
In- the- money options (ITM) – An in-the-money option is an option that would lead to positive cash flow to the holder if it were exercised immediately. A Call option is said to be in-the-money when the current price stands at a level higher than the strike price. If the Spot price is much higher than the strike price, a Call is said to be deep in-the-money option. In the case of a Put, the put is in-the-money if the Spot price is below the strike price.
At-the-money-option (ATM) – An at-the money option is an option that would lead to zero cash flow if it were exercised immediately.An option on the index is said to be “at-the-money” when the current price equals the strike price.
Out-of-the-money-option (OTM) – An out-of- the-money Option is an option that would lead to negative cash flow if it were exercised immediately. A Call option is out-of-the-money when the current price stands at a level which is less than the strike price. If the current price is much lower than the strike price the call is said to be deep out-of-the money. In case of a Put, the Put is said to be out-of-money if current price is above the strike price.