Many people think that options are a new trading product, but they are terribly wrong. The very first options contracts date back to ancient Greece and were used to speculate on the olive harvest. The story begins with Thales and the Olive harvest.
Thales of Miletus was a philosopher in ancient Greece who had profited from an olive harvest. He had a strong interest in mathematics, astronomy and economics. With his knowledge and strong interest of math, astronomy and economics he essentially created the very first options contract. By studying the stars, Thales predicted that there would be big olive harvest in his area and went on to profit from his speculation. He predicted that there would be a strong demand for olive presses and basically wanted to own the market for them.
The only problem was that he didn’t have enough money to buy all the olive presses. What he ended up doing is paying all the owners of the presses a sum of money in order to have the rights to use them at harvest season. When harvest season came around the corner, Thales’s prediction of a large harvest was right. The harvest ended up being massive. Needless to say the demand for olive presses went up. He ended up reselling his rights to the olive presses to people who wanted them and made a healthy profit. This type of deal was not common and by doing so Thales essentially created the first call option with the olive presses acting as the underlying asset.
TULIP BULB MANIA
Another instance of options trading in history is Tulip Mania in 17th
century Holland. This is commonly known and referred to as “Tulip Bulb Mania”. During the 17th century, tulips were very popular in the Holland region and were a status symbol in the Dutch community. Their popularity slowly spread throughout Europe and the rest of the world, which inevitably led to a massive increase in their demand.
During this time in history, call options and put options were being used in different markets, mainly to hedge price fluctuations. For example, tulip growers bought “puts” as protection for their profits in case the price of tulip bulbs went down. The tulip wholesalers bought “calls” as protection against the price of tulip bulbs going up. The options contracts that were created back then were not standardized and were completely unregulated.
The price of tulip bulbs continued to rise over the years and eventually the bubble popped. Tulip prices had gotten so high that they became unsustainable. The buyers began to slowly dwindle away as the prices began to tank. People who had risked everything they had on tulips were completely wiped out. People lost their savings, houses and livelihoods.
At this point the Dutch economy slid into a recession. Since the options market at that time was unregulated and non-transparent, there wasn’t a due process to make investors fulfill their obligations on their options contracts. This gave options a bad reputation for the following years and transactions slowly decreased.
Shortly following the Tulip Bulb Mania crash, options began to get banned in several parts of the world including: Europe, Japan and some major states in the US. They were still very appealing to many investors because they offered great leverage. Traders still continued to trade them where they could but their bad reputation kept their transaction volume low. They eventually got permanently banned and made illegal in the 18th century. This lasted over 100 years until they were resurrected back in the 19th century by a man named Russell Sage.
RUSSELL SAGE
Russell Sage was a notable American financier in the late 19th century who created a way to trade options over the counter in the United States. What Sage did was essentially create the relationship of pricing between options and their underlying assets. What Sage did was use the principle of a put call parity to devise synthetic loans that were then created to buy shares of stock and a related put option from a customer. This allowed Sage to loan money to people and set the interest rate that he wanted by fixing the price of the contracts and their strike prices. This led to significant losses and Sage eventually stopped trading this way. Sage was a key figure in the development of options pricing and trading.
During the 1800’s, brokers and dealers began to place advertisements in newspapers to pull in buyers and sellers of options contracts with a view of the available deals that were getting priced. They hoped that the interested party would call the broker and buy either calls or puts on a particular equity. The broker would then try to find another person willing to take the opposite side of that transaction. The process was slow and cumbersome. This eventually led to the formation of the Dealers Association. The terms of the contracts were determined by the two parties. The contracts were not standardized or regulated during that time. Since they were unregulated many investors remained wary which led to thin volume.
DEALERS ASSOCIATION
The options market continued to be controlled and run by the Dealers Association, with the options contracts being traded over the counter. The contracts slowly started to become more standardized and people became more educated on their functionality and investment potential. The activity slowly began to pick as more options were introduced on different equities. The brokers in the Dealers Association made their money from the spread between the buyers and the sellers of the options contracts. Since there was a lack of regulation and standardization in the contracts, the pricing on the options contracts didn’t have a good structure. The brokers could price out the contracts with very wide spreads. Investors still didn’t see options as a viable investing instrument.
CHICAGO BOARD OF TRADE
In late 1960’s, the Chicago Board of Trade began to see a major drop in trading volume for commodity futures and it began to look for new ways to continue its growth. Their goal was to offer more instruments for trading so they could diversify the base of their offerings to the public. After much thought and consideration they decided to create an exchange for trading options. This would not be an easy task.
In 1973, the Chicago Board of Options Exchange (CBOE) was open for trading. Contracts were officially standardized and had proper pricing structure. To make things even better, the Options Clearing Corporation was also formed to regulate and oversee the clearing and fulfillment of options contracts. This helped to legitimize the trading of options and investors were now fully confident in using them as a solid investment.
Over the next following decades the market continue to change and evolve with options being offered on different instruments and markets. More options exchanges were introduced and trading volume picked up exponentially. By the end of the 20th century, online trading began to gain massive interest and popularity.
Trading that was once available to a select few was now available to the general public. Online brokers began to pop up left and right and professional and newbie traders could now sit behind their laptops and fire off trades. The options market exploded and volumes grew to historical levels. At the end of 2015, the CBOE boasted an annual trading volume of 1.27 billion contracts traded. The CBOE now offers options on over 2,300 companies, 22 stock indices and over 140 ETF’s. The evolution of options from where it began to where it is today is a remarkable feat. So now you have a bit of history of how options began and where they are today.
Very interesting and great writing!
Thanks!