Options markets, Financial Management

Options Markets:

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.

  • In options, the obligation to honor the contract is on the writer of the option, whereas in futures both the parties are equally responsible to honor their obligations.
  • In options, the buyer has to pay the premium to the writer of the option. In futures, both the parties have to deposit the initial margin with the clearing house and then have to pay variation margin depending on whether the price fluctuation is favorable to them or not.
  • American options can be exercised any time before the expiration day, while the European options should be exercised on the last day of expiration period. In futures, no such distinction exists and the parties are expected to honor the contract on the settlement date.
  • In options, the buyer limits the downside risk to the extent of premium paid. He, however, retains the upside potential. In futures, the buyer is exposed to the whole of the downside risk and has the potential for all the upside return.
  • The expiration period for options is nine months, while for futures it is twelve months.
  • Options are employed by both hedgers and speculators, while trading in futures is by and large done by speculators.

 

Posted Date: 9/10/2012 9:23:35 AM | Location : United States







Related Discussions:- Options markets, Assignment Help, Ask Question on Options markets, Get Answer, Expert's Help, Options markets Discussions

Write discussion on Options markets
Your posts are moderated
Related Questions
Tests in Investments There are many rules that specify how the past data of share prices can be used to obtain a clue regarding the future prices of shares. Such rules would be

Social responsibility The firm must decide whether to operate strictly in their shareholders' best interests or be responsible to their employers, their customers, and the soc

"The emphasis on the practice of good corporate governance has brought about more negative than positive implications to public-listed companies". Do you agree with the above st

Control ratios: Three important ratios are usually used by the management to find out whether the variations from budgeted results are unfavorable or favorable.  These ratios are

What is the financial leverage effect and what causes it?  What are the potential benefits and negative consequences of high financial leverage? Financial leverage is the extra

Q. Working Capital as a Percentage of Total Assets? This approach of estimation of working capital requirement is based on the fact that the total assets of the firm arc consis

In indexed bonds, the principal and coupon payments are linked to the market index like inflation and price index. Index bonds are attractive to investors

Need for Simulation If the mathematical model set up could always be optimized by the analytical approach, then, there would be no need for simulation. Only when interrelation

Dev's Spa has cash of $50, accounts receivable of $60, accounts payable of $200, inventory of $150 and accured expenses of $100. What will be the value of the quick ratio?

A mortgage may be defined as a pledge of property to secure a debt payment; in this context, we will use the term property to mean real estate. If the