Derivatives are a broad class of financial instruments which primarily include options and futures. These instruments get their price and value which is based on an underlying asset. Underlying assets could include:
- Commodities such as coffee, grains, cotton, etc.
- Precious metals such as gold, silver, copper, etc.
- Shares, Government Bonds, T-bills
- Over the counter money market products
Derivative trading has a 10,000-year-old history. In humanity’s financial history, derivatives have always had a place. From Babylonians to the medieval era to the current electronic age, derivatives have existed all this while. Here we trace the history of derivative trading and its current scenario.
The Ancient Times
In 8,000 B.C., to deliver a number of goods by a certain date, clay token was exchanged in envelopes. The time frame was decided by the imprint on the envelope and the tokens themselves. This process functioned like that of a forward’s contract. The contract got once settled as soon as the seller delivered the goods as per the imprints on the token. In late 1700, B.C. came the written contracts. These agreements were detailed with the purchase and sale dates. They sometimes also functioned as future contracts wherein the date for the delivery of gains was pre-mentioned based on an agreed upon price.
The Medieval Times
In the 1700s, Japan established the Dojima Rice Exchange. This was the rice market in Osaka, Japan, where rice was auctioned. To participate in the auction and exchange, the traders had to establish a line of credit first with a clearinghouse. Futures and options kept evolving as merchants during the middle ages negotiated partnerships for ventures on the sea and land. In 1515 the city of Antwerp in Belgium opened its first building, where traders, both local and international, could trade in commodities directly.
The Modern Times
There came a time when the agricultural demand in the US required trading contracts. For this purpose, the Chicago Board of Trade was formed. The exchange started using forward contracts, followed by the counterparty future agreements.
The Age of Computers
With the introduction of computers and the internet, options, and hedging prices became better defined. Then came the electronic transformation which made trading electronic and gave a worldwide expansion to trading in the derivatives market.
Derivative Trading in India
Derivative trading in India has existed in some form or another for a long time. Back in 1875, the Bombay Cotton Exchange started trading in futures. In the year 1995 came the promulgation of the Securities Laws Ordinance. This ordinance withdrew the prohibition of options trading in securities. Derivative trading in India started in the earnest in June 2000. The final approval came in May 2001. SEBI permitted derivative trading on the two stock exchanges, the NSE and the BSE. Since then the equity derivatives market in India has seen huge growth.
With the advent of online trading, it is evident that derivative trading has greatly shaped the financial market in India and worldwide. Risk management and safe and secure trading platforms have given a required boost to derivative trading in India.