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Many people think of options trading is a relatively new form of investment when compared to other more traditional forms such as buying stocks and shares. The modern options contracts as we know them were only really introduced when the Chicago Board of Options Exchange CBOE was formed, but the basic concept of options contracts is believed to have been established in Ancient Greece: Since that time options have been around in one form or another in various marketplaces, right up until the formation of the CBOE in , when they were properly standardized for the first time and options trading gained some credibility.
On this page we provide details on the history of options and options trading, starting with Ancient Greece and going right through until the modern day. The earliest recorded example of options was referred to in a book written in the mid fourth century BC by Aristotle, a Greek philosopher of great influence and writer on many subjects. In this book, entitled "Politics", Aristotle included an account about another philosopher, Thales of Miletus, and how he had profited from an olive harvest.
Thales had great interest in, among other things, astronomy and mathematics and he combined his knowledge of those subjects to create what were effectively the first known options contracts. By studying the stars, Thales managed to predict that there would be a vast olive harvest in his region and set out to profit from his prediction.
He recognized that there would a significant demand for olive presses and wanted to basically corner the market. However, Thales didn't have sufficient funds to own all the olive presses so he instead paid the owners of olive presses a sum of money each in order to secure the rights to use them at harvest time. Although the term wasn't used at the time, Thales had effectively created the first call option with olive presses as the underlying security.
He had paid out for the right, but not the obligation, to use the olive presses at a fixed price and was then able to exercise his options for a profit. This is the basic principle for how calls work today; now we have other factors such as financial intruments and commodities instead of olive presses as the underlying security. Another relevant occurrence in the history of options was an event in 17th century Holland which is widely referred to as Tulip Bulb Mania. At the time, tulips were incredibly popular in the region and were considered to be status symbols among the Dutch aristocracy.
Their popularity spread into Europe and throughout the world, and this led to a demand for tulip bulbs increased at a dramatic rate. By this point in history, calls and puts were being used in many different markets, primarily for hedging purposes.
For example, tulip growers would buy puts to protect their profits just in case the price of tulip bulbs go down. Tulip wholesalers would buy calls to protect against the risk of the price of tulip bulbs going up.
It's worth noting that these contracts weren't as developed as they are today, and options markets were relatively informal and completely unregulated. During the s, the demand for tulip bulbs continued to increase and because of this, the price also went up in value.
The value of tulip bulb options contracts increased as a result, and a secondary market for these contracts emerged which enabled anyone to speculate on the market for tulip bulbs. Many individuals and families in Holland invested heavily in such contracts, often using all their money or even borrowing against assets such as their property.
The price of tulip bulbs continued to rise, but it could only continue for so long and eventually the bubble bursted. Prices had risen to the point where they were unsustainable, and the buyers started to disappear as the prices began to plummet. Many of those that had risked everything on the price of tulip bulbs continuing to rise were completely wiped out. Ordinary people had lost all their money and their homes. The Dutch economy went into a recession. Because the options market was unregulated, there was no way to force investors to fulfill their obligations of the options contracts, and this ultimately led to options gaining a bad reputation throughout the world.
Despite the bad name that options contracts had, they still held appeal for many investors. This was largely down to the fact that they offered great leverage power, which is actually one of the reasons why they are so popular today. So trading of these contracts continued to take place, but they were unable to shake their bad reputation. There was an increased opposition to their use. Throughout history, options have been banned numerous times in many parts of the world: Perhaps the most notable of bans was in London, England.
Despite the development of an organized market for calls and puts during the late s, opposition to them wasn't overcome and eventually options were made illegal in the early eighteenth century.
A notable development in the history of options trading involved an American financier by the name of Russell Sage. In the late 19th century, Sage began creating calls and puts options that could be traded over the counter in the United States.
There was still no formal exchange market, but Sage created activity that was a significant breakthrough for options trading. He used the principle of a put call parity to devise synthetic loans that were created by him buying stock and a related put from a customer. This enabled him to effectively loan money to the customer at an interest rate that he could set by fixing the price of the contracts and the relevant strike prices accordingly. Sage eventually stopped trading in his way because of significant losses, but he was certainly instrumental in the continued evolution of options trading.
During the late s, brokers and dealers started to place adverts to attract buyers and sellers of options contracts with a view to brokering deals. The idea was that an interested party would contact the broker and express their interest in buying either calls or puts on a particular stock. The broker would then try and find someone for the other side of the transaction. This was a somewhat laborious process, and the terms of each contract were essentially determined by the two relevant parties.
The Put and Call Brokers and Dealers Association was formed with a view to establishing networks that could help match buyers and sellers of contracts more effectively, but there was still no standard for pricing them and there was a distinct lack of liquidity in the market. The trading of options was certainly increasing by this point, although the lack of any regulation meant that investors were still wary.
The market for options continued to essentially be controlled by put and call brokers with contracts being traded over the counter. There was some standardization in the market, and more people became aware of these contracts and their potential uses. The market remained relatively illiquid with limited activity at this time. The brokers were making their profits from the spread between what the buyers were willing to pay and what the sellers were willing to accept, but there was no real correct pricing structure and the brokers could set the spread as wide as they wanted.
Even though the Securities and Exchange Commission SEC in the United States had bought some regulation into the over the counter options market, by the late s the trading of them wasn't really progressing at any noticeable rate.
There were too many complexities involved and inconsistent prices made it very difficult for any investor to seriously consider options as a viable tradable instrument.
It was an essentially unrelated occurrence in that eventually led to a solution that would ultimately bring the options market into the mainstream. In , the Chicago Board of Trade saw a significant decline in the trading of commodity futures on its exchange, and the organization began to look for new ways to grow their business.
The aim was to diversify and create additional opportunities for members of the exchange to trade. After considering a number of alternatives, the decision was made to create a formal exchange for the trading of options contracts. For the first time, options contracts were properly standardized and there was a fair marketplace for them to be traded.
At the same time, the Options Clearing Corporation was established for centralized clearing and ensuring the proper fulfillment of contracts. Thus, removing many of the concerns investors still held about contracts not being honored. Over 2, years after Thales had created the first call, the trading of options was finally legitimate. When the CBOE first opened for trading, there were very few contracts listed, and they were only calls because, puts hadn't been standardized at this point.
There was also still some resistance to the idea of trading options, largely down to difficulties in determining whether they represented good value for money or not. The lack of an obvious method for calculating a fair price of an option combined with wide spreads meant that the market was still lacking in liquidity. Another significant development helped to change that just a short time after the CBOE was opened for trading.
In that same year, , two professors, Fisher Black and Myron Scholes, conceived a mathematical formula that could calculate the price of an option using specified variables.
This formula became known as the Black Scholes Pricing Model , and it had a major impact as investors began to feel more comfortable trading options. By the average daily volume of contracts exchanged on the CBOE was over 20, and in two more options trading floors were opened in America. In , the number of stocks on which options could be traded was increased and puts were also introduced to the exchanges.
In the following years, more options exchanges were established around the world and the range of contracts that could be traded continued to grow. Towards the end of the 20th century, online trading began to gain popularity, which made the trading of many different financial instruments vastly more accessible for members of the public all over the world. The amount and quality of the online brokers available on the web increased and online options trading became popular with a huge number of professional and amateur traders.
In the modern options market there are thousands of contracts listed on the exchanges and many million contracts traded each and every day.
Options trading continues to grow in popularity and shows no signs of slowing down. The History of Options Trading Many people think of options trading is a relatively new form of investment when compared to other more traditional forms such as buying stocks and shares.
Thales and the Olive Harvest The earliest recorded example of options was referred to in a book written in the mid fourth century BC by Aristotle, a Greek philosopher of great influence and writer on many subjects.
Tulip Bulb Mania in the 17th Century Another relevant occurrence in the history of options was an event in 17th century Holland which is widely referred to as Tulip Bulb Mania. Bans on Options Trading Despite the bad name that options contracts had, they still held appeal for many investors. This ban lasted over years and wasn't lifted until later in the nineteenth century.
The Listed Options Market The market for options continued to essentially be controlled by put and call brokers with contracts being traded over the counter. Continued Evolution of Options Trading When the CBOE first opened for trading, there were very few contracts listed, and they were only calls because, puts hadn't been standardized at this point. Read Review Visit Broker.