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Futures and Options Market


Derivatives are financial instruments whose value depends on the value of one or more other basic variables called underlying assets or values. The most prevalent derivative instruments are futures contracts, option contracts, and swaps.

As defined by current regulations, futures are contracts whose term, amount, quantity, quality, and other features are standardized. They allow the user to buy or sell an underlying asset at a certain price, to be settled at a future date. Options are standardized contracts in which the buyer pays a premium in return for the right, but not the obligation, to buy in call options) or sell (in put options) an underlying asset at an agreed- upon price (called the strike price) at a future date, and the seller of the option is obliged to sell or buy the underlying, as the case may be, at the agreed-upon price.

Futures and options may be standardized, in which case they are generally traded in a physical venue or exchange, or made to order, with no specific expiration date, size or quality, in which case they are generally traded off the market or over the counter. Those who participate in these markets can be arbitrageurs, speculators, or risk hedgers, and they may take either buy positions (long) or sell positions (short).

The origins of the futures market go back to the Middle Ages. Futures were born out the need to meet the demands of farmers and tradesman. If a farmer began planting wheat in January, with the idea of harvesting it in June, he needed to be certain of the price he could sell his wheat in June. In years of scarcity, the price of wheat was likely to remain high, while in years of abundance the wheat was likely to be sold at lower prices. Under this scenario, the farmer took on a risk in setting the price at which he would sell his wheat. This is what gave rise to futures contracts.

The first options contracts were seen in Europe and the United States in the 18th century, although they had a rather shady reputation at first because of certain fraudulent practices such as giving brokers options on the shares of certain companies to encourage them to recommend buying the stocks to their clients.

Although initially, both types of contract were traded over the counter, problems of default on quality, delivery dates and amounts were rife, requiring a standardization of contracts and the creation of the first clearinghouses. These clearinghouses began to act as counterparty for all transactions, ensuring delivery and payment of the products by charging a premium to buyers until the transaction was final, and collecting a guarantee from sellers on their sales. Thus, many times the seller could in turn transfer the delivery rights to another farmer. In other words, he could trade the contract before its expiration. Similarly, the buyer could trade their purchase rights with another participant. The seller could be sure he would receive a certain amount of money in the future for his wheat, and the buyer could be sure of obtaining a certain amount of wheat at a certain price in the future.

As technology progressed, futures and options contracts became very popular, and numerous venues (exchanges) began to open around the world, listing a wide variety of underlying assets: perishable goods, metals, interest rates, foreign currency, stocks, indices, etc. The market for exchange-listed options and futures has been highly successful. One reason is that they offer the industry ways of hedging the risks to which they are exposed each day in a flexible, relatively cheap and highly secure way.

Starting in the 1970s, the market for exchange-listed futures and options based on interes t rates, foreign currency and indices began to grow. By 1995, annual trading volume on the different world derivatives market reached 327 trillion dollars.


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