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The year 1973, was the year the year of the options market. The world’s first options market opened that year, as well as the famous Black-Scholes model in their article about options prices independent from preferences (this model was later perfected by Merton), which gave a rational tool in the hands of options traders. Today the derivatives market is one of the fastest growing market in the world. The total trading volume in 2007 was estimated to have exceeded USD 500 trillion. By 2012, the total value of the derivatives market exceeded USD 1200 trilllion; an incredible growth and an astronomical size of a market. In fact, the size of the derivatives market in that year was more than 17 times the size of the world economy. The diversity and complexity of new financial products on this market is amazing. Serious mathematical research is going on around the world to come up with newer and more accurate models to fit the ever growing need for these financial products.
Derivatives are such financial products whose value depends on (derived from) the sum of the values of two or more underlying products, hence the name “derivatives”. The behaviors of the derivatives are also determined by these underlying products. In fact these derivatives are almost always “contract”, and the value of predefined exchange rates between the two or more products are valued, bought and sold (American type) constantly as the contracts (or rather the rights in those contracts). In contrast to the traditional securities trading, such as stock trading, derivatives have a “contract fee” which must be paid by trader and is a fully “lost money”, irrespective of whether the trader exercises his/her contractual right upon the expiry of the contract, or not. This contract fee is usually between 1-5 percent of the full (expiry) value of the contract. On the other hand derivatives are usually highly leveraged, meaning that much of the contract value is purchased on credit (which in the event of profits means very high profits).
Financial Markets vol. I. Functioning of Financial Markets
Beata Majer, Julia Kiraly
International Banker Training Center LLC.