Derivative Market in India: Development of “F&O” Segment

Organized derivatives in India started as early as 1875, barely about a decade after they started in Chicago. In this era of globalisation, the world is a riskier place and exposure to risk is growing. Risk cannot be avoided or ignored. Man, however is risk averse. The risk averse characteristic of human beings has brought about growth in derivatives. Derivatives help the risk averse individuals by offering a mechanism for hedging risks. Futures and options have had a lively existence for several centuries. Financial derivatives came into the limelight in the post-1970 period; today they account for 75 percent of the financial market activity in Europe, North America, and East Asia. The basic difference between commodity and financial derivatives lies in the nature of the underlying instrument. In commodity derivatives, the underlying asset is a commodity; it may be wheat, cotton, pepper, turmeric, corn, orange, oats, Soya beans, rice, crude oil, natural gas, gold, silver, and so on. In financial derivatives, the underlying includes treasuries, bonds, stocks, stock index, foreign exchange, and Euro dollar deposits. The market for financial derivatives has grown tremendously both in terms of variety of instruments and turnover. In the decade of 1990’s revolutionary changes took place in the institutional infrastructure in India's equity market. One aspect of the sophistication of the equity market is seen in the levels of market liquidity that are now visible. A separate association by the name “Bombay Cotton Exchange Ltd” was established following widespread discontent amongst leading cotton mill owners and merchants over the functioning of the Bombay Cotton Trade Association. There are many Factors contributing to the explosive growth of derivatives are price volatility, globalisation of the markets, technological developments and advances in the financial theories. Now globalisation has increased the size of markets and as greatly enhanced competition. it has benefited consumers who cannot obtain better quality goods at a lower cost. It has also exposed the modern business to significant risks and, in many cases, led to cut profit margins. Advances in financial theories gave birth to derivatives. However, there are several impediments to be overcome and issues to be decided for sustainable development of the market. The Government of India is contemplating allowing the Institutional investors like Foreign Institutional Investors, Mutual funds and Banks to trade in a few selected products of commodity derivatives markets in India. This paper attempts to answer questions such as: Is this progress sustainable and what are the obstacles that need urgent attention if the market is to realize its full potential? Why are derivatives important and what could other emerging economies learn from the Indian mistakes and experience?