Financial derivatives

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Financial derivatives are clever things that clever financial professionals create. Probably the first financial derivatives were – but don’t quote me – futures contracts. These were developed to give farmers and merchants who were buying the farmers produce more predictable prices. While farmers and merchants worked out that it made their lives and hence livelihoods a little more predictable if they agreed to buy and sell each other contracts for the future delivery or receipt of a set quantity of agricultural produce at a set date, speculators hanging out around the markets saw an opportunity. Once a futures contract is created circumstances change and the farmers and merchants trade their contracts and the prices of the contracts will change over their life. If circumstances have changed dramatically by the time a futures contract matures then the market spot price may differ dramatically from the future contracted price. Speculators realized they could trade these contracts before the contracts reached maturity and benefit from changing prices as weather and harvests behaved in unpredictable ways trading back out of before to avoid finding themselves having to store a few tons of pork bellies for example. Thus futures and futures trading was born. Then at some point someone realized that you could also create a contract to give someone the right but not the obligation to buy or sell an asset or a good at a set price before a set date. Thus options were born. And then you have options on futures and after that all manner of financial derivatives continue to be created. Would it be possible to sell a put option on a future for a tranche of securitized mortgage loans on houses that haven’t been built yet? probably.

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Andy