So, Chinese investors will soon have the option to trade options. Great! As options do give investors lots of opportunities to make money from market movements or the lack of movements. In this series, we will introduce options as a strategic investment vehicle.
History of Options
The first unambiguously historical reference to options is in “The Politics” by Aristotle. He tells the story of the philosopher Thales of Miletus who lived from 624 to 527 B.C. Its eems that Thales eventually grew tired of hearing variants of the question, “If you are so smart why aren’t you rich?” and resolved to show that learning could indeed lead to riches. According to Aristotle:
He, deducing from his knowledge of stars that there would be a good crop of olives, while it was still winter raised a little capital and used it to pay deposits on all the oil-presses in Miletus and Chios, thus securing an option on their hire. This cost him only a small sum as there were no other bidders. Then the time of the harvest came and as there was a sudden and simultaneous demand for oil-presses, he hired them out at any price he liked to ask.
Thales actually bought a call option. The deposits bought him the right, but not the obligation, to hire the presses. If the harvest had been poor, Thales would have chosen not to exercise his right to rent the presses and lost only the initial deposit, the option premium. Fortunately, the harvest was good and Thales exercised the option. Aristotle concludes,
He made a lot of money and so demonstrated that it is easy for philosophers to be rich, if they want to.
In the United States options began trading in the eighteenth century. By the nineteenth century an active over-the-counter business in equity options had developed. This market had a well-defined structure. Wealthy individuals would sell blocks of puts and calls to brokers who would in turn sell them to smaller speculators. This arrangement helped to mitigate against credit risk, as the smaller traders were only allowed to purchase options and had to pay in full for the options up front. These options were commonly referred to as “privileges,” because the purchaser had the privilege of exercising the option and calling (or putting) the stock but was under no obligations.
Trading in the United States, Early 20th Century
While the market was active, it was not considered socially acceptable. In 1874 the Illinois state legislature made option trading illegal. Other states followed, often because of the idea that speculation was harmful to “real” businesses and was nothing more than a form of gambling. Option trading was generally considered no more legitimate than trading in bucket shops or even participating in outright financial frauds.
Due to the counterparty risk, this market was mainly one of issuance. The options would trade in a secondary market, but this was far more illiquid. Over the next hundred years, this market developed in size but remained over-the-counter.
During this time, traders gradually developed many of the rules of thumb that we still use today. The equivalence of puts and calls was well understood, as were the ideas behind hedging with the underlying and other options. There were also several option pricing models being used by the more advanced traders. In fact it is likely that traders were using the essential features of the Black-Scholes-Merton model in this period.
Chicago Board Of Trade (CBOT), 1971
The first exchange to list standardized contracts was the Chicago Board Options Exchange (CBOE). These started trading on April 26th, 1973. The publication in the same year of the famous Black-Scholes pricing model (now more correctly referred to as the Black-Scholes-Merton model) also boosted the market as more and more people thought they could now successfully price and hedge options. Initially options were listed on 16 stocks. Today options on thousands of stocks, indices, currencies and futures trade on at least 50 exchanges in over 30 countries.
The Black-Scholes-Merton Options Picing Model:
Myron S. Scholes and Robert C. Merton were awarded the Nobel Prize in Economics in 1997 for their work on options pricing model.
The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1997
Myron S. Scholes, Stanford University, U.S.A
Robert C. Merton, Harvard University, U.S.A
In addition to this enormous expansion of the universe of underlyings, the total activity has increased exponentially. The figure blow shows the total volume inU.S. stock options annually since 1973.
Options trading has a long history
Modern exchange-listed options trading started in 1973 on CBOE in the United States
Over the past 40 years, options trading has gained tremendous volume, and options are listed for increasingly more underlyings, including stocks, FX, futures, indices, you name it
China is late to the game, but given the enormous size of the Chinese financial market and the Chinese government's will to catch up, we expect huge growth in options trading and an unmet need for options trading/investment education in the years to come
Our company is dedicated to world-class trading/investing technology and training, including options trading and training. Indeed, our company's name is intimately related to options:
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