INTRODUCTION TO OPTIONS
In this section, we look at the next derivative product to be traded on the -NSE, namely Options. Options are fundamentally different from forward and futures contracts. An option gives the holder of the option the right to do something. The holder does not have to exercise this right. In contrast, in a forward or futures contract, the two parties have committed themselves to doing something. Whereas it costs nothing (except margin requirements) to enter into a futures contract, the purchase of an option requires an up-front payment.
HISTORY OF OPTIONS
Although options have existed for a long time, they were traded OTC, without much knowledge of valuation. The first trading in Options began in Europe and.the US as early as seventeenth century. It was only in the early 1900s that a group of firms set up what was known as the put and call Brokers and Dealers Association with the aim of providing a mechanism for bringing buyers and sellers together. If someone wanted to buy an option, he or she would contract one of the member firms. The firm would then attempt to find a seller or writer of the option either from its own clients or those of other member firms. If no seller could be found, the firm would undertake to write the option itself in return for a price.
This market however suffered from two deficiencies. First, there was no secondary market and second, there was no mechanism to guarantee that the writer of the option would honor the contract, in 1073, Black, Merton and Scholes invented the famed Black-Scholes formula. In April 1973, CBOE as setup specifically for the purpose of trading options. The market for options developed so rapidly that by early 80s, the number of shares underlying the option contract sold each day exceeded the daily volume of shares traded on the NYSE. Since then, there has been no looking back.
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