A derivative security is a financial instrument whose value is derived from and linked to the value of another underlying asset, right, or variable, rather than from its own standalone characteristics. The underlying reference may be an equity security, interest rate, commodity, currency, or market index, and the derivative’s value changes in response to movements in that reference.
In U.S. securities regulation, the term derivative security has a specific meaning in the context of insider reporting under Section 16 of the Securities Exchange Act of 1934. For these purposes, Exchange Act Rule 16a-1(c) defines derivative securities to include instruments such as options, warrants, convertible securities, stock appreciation rights, and similar rights with an exercise or conversion privilege at a price related to an equity security, or with a value derived from the value of an equity security (17 CFR § 240.16a-1(c), https://www.law.cornell.edu/cfr/text/17/240.16a-1).
Regulatory Reporting Context
Under Section 16(a), officers, directors, and certain beneficial owners must disclose holdings and transactions involving derivative securities on Form 3, Form 4, and Form 5. Rule 16a-4 specifies how transactions involving derivative securities are treated for reporting purposes, including how exercises or conversions of derivative securities are reported in relation to the underlying equity security (17 CFR § 240.16a-4, https://www.law.cornell.edu/cfr/text/17/240.16a-4). The rule governs how changes in beneficial ownership arising from derivative positions are reflected in insider reports, rather than treating derivative instruments as separate equity classes.
The SEC’s Form 4 instructions reflect this structure by requiring derivative securities to be disclosed in separate tables from non-derivative equity securities, even though both relate to the same underlying class of equity (https://www.sec.gov/files/form4data.pdf).
Common Forms
Within the Section 16 reporting framework, commonly encountered derivative securities include:
- Options, which may give rise to an option exercise resulting in the acquisition or disposition of the underlying equity
- Warrants, which grant a right to purchase equity, often issued by the issuer itself
- Convertible securities, such as debt or preferred stock that may be converted into equity
- Stock appreciation rights and similar instruments, whose value is tied to changes in an equity security’s market price
Outside the Section 16 context, the term “derivative security” is also used more broadly in financial markets to describe instruments whose value depends on an underlying reference, though not all such instruments fall within the scope of Section 16 reporting or equity-linked definitions such as a stock option.
Sources
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17 CFR § 240.16a-1(c) — Definition of derivative securities for Section 16 reporting
https://www.law.cornell.edu/cfr/text/17/240.16a-1 -
17 CFR § 240.16a-4 — Treatment of derivative securities in insider reporting
https://www.law.cornell.edu/cfr/text/17/240.16a-4 -
SEC Form 4 Data Instructions — Reporting of derivative and non-derivative securities
https://www.sec.gov/files/form4data.pdf -
Investor.gov — Derivatives — General financial description of derivatives
https://www.investor.gov/introduction-investing/investing-basics/glossary/derivatives