Came a really interesting paper which outlines a short history of derivatives. Given that most of the users here are F&O traders, you guys might find this interesting. Personally, I highly recommend it.
Here are a few interesting excerpts:
Contracts for future delivery of commodities spread from Mesopotamia to Hellenistic Egypt and the Roman world. After the collapse of the Roman Empire, contracts for future delivery continued to be used in the Byzantine Empire in the eastern Mediterranean and they survived in canon law in western Europe.
It is likely that Sephardic Jews carried derivative trading from Mesopotamia to Spain during Roman times and the first millennium AD, and, after being expelled from Spain, to the Low Countries in the sixteenth century. The first derivatives on securities were written in the Low Countries in the sixteenth century.
Derivative trading on securities spread from Amsterdam to England and France at the turn of the seventeenth to the eighteenth century, and from France to Germany in the early nineteenth century. Circumstantial evidence indicates that bankers and banks were at the forefront of derivative trading during the eighteenth and nineteenth centuries.
Writing was invented in Mesopotamia in the fourth millennium BC. The invention of writing satisfied the administrative and commercial needs of the first urban society in human history. The first derivative contracts were written in cuneiform script on clay tablets, which, luckily for financial historians, are extremely durable. These derivatives were contracts for future delivery of goods that were often combined with a loan. Van de Mieroop (2005) reproduces a tablet in which a supplier of wood, whose name was Akshak-shemi, promised to deliver 30 wooden [planks?] to a client, called Damqanum, at a future date. The contract was written in the nineteenth century BC.
“Thirty wooden [planks?], ten of 3.5 meters each, twenty of 4 meters each, in the month Magrattum Akshak-shemi will give to Damqanum. Before six witnesses (their names are listed). The year that the golden throne of Sin of Warhum was made.” (van de Mieroop 2005, p. 23)
The main trading centers in northern Europe were Bruges from the twelfth to the fifteenth century, Antwerp in the sixteenth century, and Amsterdam in the seventeenth century. Bruges was a center for the trade of wool, cloth and other commodities. Around 1540, Antwerp legalized the negotiability of bills of exchange and a royal decree made contracts for future delivery transferable to third parties.
At about this time, an important innovation occurred in derivative markets. Merchants discovered that there is no need to settle forward contracts by delivering the underlying asset, as it is sufficient if the losing party compensates the winning party for the difference between the delivery price and the spot price at the time of settlement. Contracts for differences were written on bills of exchange, government bonds and commodities.
Although it is 11 likely that similar deals had been done in Bruges and with monti shares in Italy, contracts for differences were used on a large scale for the first time in Antwerp.
The first short selling attack
The foundation of the Dutch East India Company was met with public enthusiasm, which
turned into disenchantment when the Company developed more slowly than expected. The share
price doubled within a few years, but about one half to three quarters of this gain was lost by
1610 (Neal 2005).Reacting to the disappointing performance of the Dutch East India Company,
Isaac Le Maire, a fugitive from Antwerp, conducted the first recorded bear attack on an underperforming firm by selling its shares short. Thus, he borrowed shares and he then sold the
borrowed shares. This was profitable if he could buy the shares back and return them to the
owner at a lower price in the future.Conceptually, there is no big step from a contract for differences to a short-selling operation. In a contract for differences the expected profit depends on the difference between the expected future spot price and the delivery price. In a short-selling operation the expected profit is determined by the difference between the expected future spot price and the current spot price.
Tulipmania
The speculation with tulip bulbs was done with contracts for differences, and possibly
options. By the time of the tulipmania, contracts for differences had been used in Holland for
about a century. It is unlikely that speculators were wealthy enough to buy tulip bulbs and hold
on to them. Indeed, contracts for differences were controversial because they gave people
leverage to speculate. In Antwerp contracts for differences were outlawed shortly after forward
contracts had been made transferable, around 1541 (Swan 2000, p. 144).But it is unlikely that this restriction was effective because a forward contract does not show how it will be settled. Even if the contract requires the delivery of the underlying asset, the parties to the contract can informally agree on a cash payment at the delivery date. In Amsterdam contracts for differences were not made illegal, instead, in 1621, 1630 and 1636, three edicts were issued with the intention to undermine contracts for differences by making them unenforceable in the courts
(Kellenbenz 1957, p. xiv).However, these edicts did not prevent the use of contracts for differences during the tulipmania. Derivative markets continued to work because the failure to honor a contract made a speculator an outcast, practically excluding him from further dealings.