Option Trading: A Primer and a Proposal

The option industry has witnessed explosive growth since 1973 when the first organized option exchange opened in Chicago. Moreover, this growth is continuing into the 1990s as entirely new types of options are created and as more of the traditional options on securities are listed and traded. Options on commodities, options on financial indices and options on future contracts are all exciting new products. Understanding these new products well enough to sell them has been straining the capacity of the world security industry. At present, instruments prevalent in India are meant primarily to raise resources from public for corporate sector. We hardly have any mechanism or instruments which would help the investors in managing the risk commensurate with their preferences. It is high time that option trading is launched in Indian stock exchanges. This paper provides a primer on option trading and a preliminary proposal for its implementation in India. For successful launching of option trading in India we would require the following: 1 The standardization of the terms of option contracts. 2 The careful selection of underlying security. 3 The appointment of a number of market makers with adequate financial resources. 4 The creation of an Option Clearing House as the single guarantor of every exchange traded option. 5 The creation of an active secondary market. 6 The creation of a central market place with its attendant regulatory, surveillance and price dissemination capabilities. 7 The creation of paperless trading and book-entry transfer system.