Man has always been innovative and ingenuous. His determination to improvise and overcome the limitations of various processes has resulted in phenomenal and epoch-making discoveries and inventions. To overcome the limitations of proprietorship firms, he discovered the limited companies concept. To limit his dependence on term lending institutions he invented various types of instruments to raise long-term as well as short-term finance like different types of debentures, commercial paper and global depository receipts.
Options and Futures are also the result of this unrelenting search for better financial instruments. They belong to a class of instruments referred to as ‘Derivatives' because they derive their value from an underlying commodity or a financial asset. The underlying commodities and financial assets can range from mundane products like wheat and cotton to precious items like gold, silver, petroleum, and financial assets like stocks, bonds and currencies. Options on commodities have existed in different forms since 1860 for products as diverse as gold, wheat and tulip bulbs in the USA. An active over-the-counter market in stock options has also existed there for nearly a century. However, large-scale manipulations by intermediaries and the absence of standardized contracts resulted in the investors incurring heavy losses due to which the commodity options disappeared from the listing of many exchanges by 1968. It was only in 1973 that organized exchanges began trading options on equities. In 1982, futures on equity and options on bonds made their appearance on stock exchanges.
Now, we shall look at some of the differences between options and futures.