options markets are global and trade contracts on a wide range
of products encompassing currencies, commodities, interest rates,
shares, indices, insurance; in fact you can find derivatives on just
about anything.
We do know that this vast array of products traded today would
seem unbelievable to the farmers and merchants of the Midwest of
the United States of America who first started trading futures con-
tracts, in a form similar to today, in the mid-1800s.
What is a futures contract?
A futures contract is a legally binding agreement to buy or sell a pre-
determined amount of a defined product at or by a set date for an
agreed price.
Did derivatives exist before the 1800s?
The development of futures markets can be traced back at least as
far as the Middle Ages and revolved around the supply and demand
of people like farmers and merchants. The early contracts were,
therefore, for delivery of ‘underlying’ products like grains, e.g. oats,
corn and wheat. These trades took place for either immediate settle-
ment (‘spot’ trades) or settlement at some time ahead (‘forward’
trades). They were not without problems. To establish the current
price for say wheat, farmers would take their harvested crops to the
major towns and visit each merchant in turn to find out who would
pay the best price. Picture the scene as hundreds of farmers going
back and forth across the town. Often many ended up dumping all
or some of their crops as they could not manage to find a buyer,
especially when there were bumper harvests. Even when the farmer
had reached agreement with a merchant before harvest time, as
there was no regulations in place there was no guarantee that the
agreement would be honoured and both parties were potentially the
‘guilty’ ones to the default if prices moved in their favour.
The first futures market
The Chicago Board of Trade (most exchanges use mnemonics/
abbreviations and in this case the one used is CBOT or in speech
sometimes ‘the Board’) was established in 1848 to standardise the
size, quality and delivery date of these commodity agreements that
were forwards contracts into a contract that could be traded on an
exchange.
2 Clearing and settlement of derivatives
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