History of Options
Ancient Origins: Although it isn't known exactly when the first option contract traded, it is known that the Romans and Phoenicians used similar contracts in shipping. There is also evidence that Thales, a mathematician and philosopher in ancient Greece used options to secure a low price for olive presses in advance of the harvest. Thales had reason to believe the olive harvest would be particularly strong. During the off-season when demand for olive presses was almost non-existent, he acquired rights-at a very low cost-to use the presses the following spring. Later, when the olive harvest was in full-swing, Thales exercised his option and proceeded to rent the equipment to others at a much higher price.In Holland, trading in tulip options blossomed during the early 1600s. At first, tulip dealers used call options to make sure they could secure a reasonable price to meet the demand. At the same time, tulip growers used put options to ensure an adequate selling price. However, it wasn't long before speculators joined the mix and traded the options for profit. Unfortunately, when the market crashed, many speculators failed to honor their agreements. The consequences for the economy were devastating. Not surprisingly, the situation in this unregulated market seriously tainted the view most people had of options. After a similar episode in London one hundred years later, options were even declared illegal.
Early Options in America: options appeared on the scene around the same time as stocks. In the early 19th Century, call and put contracts — known as "privileges" — were not traded on an exchange. Because the terms differed for each contract, there wasn't much in the way of a secondary market. Instead, it was up to the buyers and sellers to find each other. This was typically accomplished when firms offered specific calls and puts in newspaper ads.
Not unlike what happened in Holland and England, options came under heavy scrutiny after the Great Depression. Although the Investment Act of 1934 legitimized options, it also put trading under the watchful eye of the newly formed Securities and Exchange Commission (SEC).
For the next several decades, growth in option trading remained slow. By 1968, annual volume still didn't exceed 300,000 contracts.
For the most part, early over-the-counter options failed to attract a following because they were cumbersome and illiquid. In the absence of an exchange, all trades were done by phone. To make matters worse, investors had no way of knowing what the real market for a given contract was. Instead, the put-call dealer functioned only to match the buyer and seller. Operating without a fixed commission, the dealer simply kept the spread between the price paid and the price sold. There was no limit to the size of this spread. Worse yet, all option contracts had to be exercised in person. If the holder of the option somehow missed the 3:15 pm deadline, the option would expire worthless regardless of its intrinsic value.
Chicago Board of Trade (CBOT): In the late 1960s, as exchange volume for commodities began to shrink, the Chicago Board of Trade (CBOT) explored opportunities for diversification into the options market. Joseph W. Sullivan, Vice President of Planning for the CBOT, studied the over-the-counter option market and concluded that two key ingredients for success were missing. First, Sullivan believed that existing options had too many variables. To correct this, he proposed standardizing the strike price, expiration, size, and other relevant contract terms. Second, Sullivan recommended the creation of an intermediary to issue contracts and guarantee settlement and performance. This intermediary is now known as the Options Clearing Corporation.
To replace the put-call dealers, who served only as intermediaries, the CBOT created a system in which market makers were required to provide two-sided markets. At the same time, the presence of multiple market makers made for a competitive atmosphere in which buyers and sellers alike could be assured of getting the best possible price.
Chicago Board Options Exchange (CBOE): After four years of study and planning, the Chicago Board of Trade established the Chicago Board Options Exchange (CBOE) and began trading listed call options on 16 stocks on April 26, 1973. The CBOE's first home was actually a smoker's lounge at the Chicago Board of Trade. After achieving first-day volume of 911 contracts, the average daily volume skyrocketed to over 20,000 the following year. Along the way, the new exchange achieved several important milestones.
As the number of underlying stocks with listed options doubled to 32, exchange membership doubled from 284 to 567. About the same time, new laws opened the door for banks and insurance companies to include options in their portfolios. For these reasons, option volume continued to grow. By the end of 1974, average daily volume exceeded 200,000 contracts.
The newfound interest in options also caught the attention of the nation's newspapers, which voluntarily began carrying listed option prices. That's quite an accomplishment considering that the CBOE initially had to purchase news space in The Wall Street Journal in order to publish quotes.
Other Exchanges Get Into the Game: Starting in 1975, a number of other exchanges began trading listed options. This group included the American Stock Exchange (AMEX), the Pacific Stock Exchange (PSE), and what is now known as the Philadelphia Stock Exchange (PHE). The most recent player to enter the game is the International Stock Exchange (ISE). Although the ISE only trades options on a limited number of stocks, the list is literally growing every day. Today, options on all sorts of financial instruments are also traded at the Chicago Mercantile Exchange, the CBOT, and other exchanges.
Courtesy: www.optionsxpress.com
