a brief history of options trading
Basics of options trading

A brief history of options trading

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Options trading is not a new form of the trading method instead, it has a long history. The concept was first used in ancient Greece and has evolved much over the years. So let us start with the first event occurred in the history of options trading

 

Thales of Miletus and the olive’s harvesting

Aristotle, an ancient Greek philosopher and a scientist mentioned first record example of options in his book “Politics” a work of political philosophy in 4th century B.C. In his book, Aristotle mentioned the story of a man named Thales of Miletus who was also a great philosopher and a mathematician. Story briefed in such a way that the observing stars and weather patterns, Thales predicted huge olive harvest in his region which was contrary to the public’s perception. Therefore he decided to take advantage of this one-sided market’s expectation and profit from it.

 But due to lack of funds to own all the olive’s presses, he instead, paid small fees to lease numerous olive’s presses for a fixed period of time and secure the rights to use them at the time of harvesting. This sounds much like an options contract. As per Thales’ expectations, it was a massive harvest and he resold the rights of all the olive’s presses to the people who needed them. By controlling the rights of olive’s presses, Thales had the right to either use the olive’s presses for himself at the time of harvesting or sell the rights to other people who needed them at a higher price. Now here, if he used the olive’s presses by himself that would be exercising his options rights but because he resold the rights which means he sold his option’s rights for profit. On the counter side olive’s press’ owners could be considered as first ones to use covered call options strategy as they own the underlying assets and sold its rights to Thales to use them and kept the small amount of premium in return.

 

The Dutch Tulipmania

Tulipmania was a major event that occurred in the dutch society in the 17th century. At this time tulips were very popular in dutch aristocracy and eventually became a status symbol. This popularity spread in whole Europe which ultimately led to an increase in demand for tulip bulbs. A rapid increase in demand and price of tulips attracted many speculators and tulips were started trading in local market exchanges. Soon everybody was trading tulip bulbs and by 1636 tulips were being traded in many European exchanges. These exchanges started options contracts which allowed speculators to trade in tulip bulbs for a small portion of the original price, moreover, options also give leverage to the trader which ultimately increase their potential profits. Due to these two reasons, many unwealthy dutches started speculating in tulip market. Mass speculation in tulip bulbs options made people buying, using all their money or selling their properties. Dutch traders aggressively speculated in tulip bulbs options believing that the market is immune to falling and will always rise.

In 1637 price bubble of tulip bulbs busted, it went so high that no buyers were there to buy it. Prices were collapsed, all options speculators were wiped out and lost all their money. Dutch economy collapsed and went into recession. As many people lost their money during tulip mania which led options to gain a bad reputation all over the world and considered as a dangerous speculative instrument.

 

Options trading in London

Even after gaining a bad reputation, options trading still appealed many traders due to its high leverage power and low premium price. At the beginning of the 18th century, London city decided to trade options and establish an organized options market. But due to bad reputation of options trading volume was kept low and due to low trading volume and increased opposition, it was declared illegal in 1733 and remained illegal for more than hundred years till it was declared legal again in 1860.

 

Options trading in the United States of America

Russel sage was an American financier who first introduced over the counter call and put options in 1872. These options were unorganized, unregulated and highly illiquid. He used put-call parity to create synthetic loans, which had higher interest rates than usury laws that would have been normally allowed. But due to significant losses in the market crash of 1884, he eventually stopped trading but over the counter market which he started, continued to work without him but still in an unregulated and unstandardized manner. Although, securities and exchange commission had brought some regulations in over the counter market, but trading was not really progressing.

After 100 years of introduction of options trading in the US market by Russel sage, a standardized exchange, Chicago board of exchange (CBOE) was formed in 1973. All options from CBOE were cleared from options clearing corporation or OCC. Now the general public was able to trade call options under the performance guarantee of OCC and liquidity provided by market makers. By 1977 the number of stocks on which options could be traded was increased and puts were also introduced in the exchange. After that many options exchanges were established around the world and options trading continues to grow in popularity.

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