A Brief History of Options

Tom LePage

Options: What are we talking about?

NOTE: this page is straight from Professor Brooks! What are the characteristics of an option contract? The agreed to underlying (remember this is a derivative asset) The agreed to price for transaction in the future (here it is the

strike or exercise price) The time horizon for the option (maturity date) The payment to the seller or writer for providing the contract

option to the buyer Call Option – The right but not the obligation to buy Put Option – The right but not the obligation to sell Buyer of the option Seller (Writer) of the option

Thales of Miletus, 624?–546? BC

Aristotle, Politics, Book 1, Section 11

predicted a great harvest of olives

gave deposits for the use of all the olive-presses in Chios and Miletus

he hired them at a low price because no one bid against him

When the harvest-time came he let them out at any rate which he pleased

From just one man... 1593-1637

1593: Carolus Clusius prefect of the Imperial Herb

Gardens in Vienna head botanist, new botanical

garden, University of Leiden many bulbs, seeds stolen these are propogated widely extremely rare at first and only

connoiseurs involvedCarnaval Variety

What the heck is a guilder? 20 stuivers = 1 guilder ½ stuiver = 1 tankard of beer 13 guilders = 1 ton herring, 1636 60 guilders = 40 gals French Brandy 250 guilders = annual salary, carpenter, 1630’s 750 guilders = Clusius’ salary 1593 3000 guilders = annual salary, wealthy

Amsterdam merchant, 1630’s 4000 guilders = entire shipload of cargo from the

new world, 1635 5200 guilders = 1637, a Violetten Admirael van

Enkhuizen (with an offset), sold at Alkmaar on February 5, 1637

1598 Guilder

A rose is a rose, but a tulip is something else

seeds produce variation; bulbs produce offsets

6-7 years, seed to flowering bulb offset = bulb in 1-2 years only 2-3 offsets/year for only for 2-

3 years offsets sometimes only breeder the irony: the multi-colored

varieties from a virus; called “breaking” back then

All this for a flower?

1624, Semper Augustus sells for 1000 guilders w/2 offsets (unverifiable reports of 5500 in 1635 & 10K in 1637!)

1633, house sells for 3 tulips! “It’s as good as cash!”

Gouda goes from 100 in December 1634 to 750 in January 1637

Holland is recovering from decade of depression 1620’s

Bubonic Plague strikes 1633-1637 5700 people, 1/8, die in Haarlem between

August and November 1636

Wanna buy a cat in a bag?

1611, Andries Mahieu asked to sell offsets: “a cat in a bag”

bulbs traded from June to September

offsets traded whenever 1635, promissory notes 1635, the ace, 1/20 gram Gerrit Bosch plants 81 ace Viceroy

in 1636 and lifts 416 aces in 1637 “windhandel” phase

Harvest the Wind

selling short outlawed 1610, 1621, 1623, 1624, 1630, 1636

huge influx of florists Dec ’36 – Jan ’37 Gaergoedt: “This trade must be done

with an intoxicated head, and the bolder one is, the better.” The Samenspraeken

Wouter Winkel dies July 1636 Tulips double, double, and double a

third time The famous Alkmaar sale February 5,

1637

How did we get here?

first, strictly flower trade then futures then futures with 10% down;

LEVERAGE 40 million guilders, 1633-1637 Dutch East India Company

capitalized at 6.5 million guilders Anybody starting to get nervous

about your futures here? ...

The Colossus topples...

December 1636, Groningen; Henricus Munting, contracts to sell 7K with 10% cancellation penalty.

Options abound, but not for long! Tuesday, February 3rd, Haarlem, at a

typical tavern college “mit borden” or “in het oujen” opening offer: one pound of Witte

Croonen for 1250 guilders is greeted by the sound of silence

No remaining records of any bulb prices in the spring of 1637

“Mr. Wizard, bring me home!” United States securities trading;

Philadelphia exchange 1791 24 New York merchants and brokers;

1792; under a tree at 68 Wall Street options known as “privileges” in the

early 19th Century; not on an exchange

1900s;Put and Call Brokers and Dealers Association formed; OTC

Investment Act of 1934; SEC 1968; 300,000 contracts

The mouse that roared... April 26, 1973; Chicago Board of

Trade (CBOT) -> Chicago Board Options Exchange (CBOE); smoker's lounge

only call options; only 16 listed stocks; 1st day 911 contracts

1974, 20K contracts daily avg 1974, SEC approves Options

Clearing Corporation (OCC): issue, guarantee, register, clear and settle all listed options on all US exchanges

How did the mouse get in the house? Gold standard abandoned during WWI

Bretton Woods, N.H; 1944; fixed exchange rates; could borrow from the International Monetary Fund (IMF)

The IMF held reserves of gold and currencies to lend

late 1940s and all through the 1950s, the United States dollar was quite strong

The United States Treasury paid 35 dollars per ounce

1970s, foreign economies grown stronger; inflation makes dollar less desirable

August of 1971 U.S. stops exchanging gold for dollars due to imbalance of payments

Black-Scholes or Black Holes?

1900 Louis Bachelier; PhD dissertation; mathematical modeling of Paris markets

1973 Fischer Black and Myron S. Scholes; THE FORMULA!

Robert C. Merton later extended the formula Texas Instruments -> one formula! model for hedging an option stabilizing a portfolio. 1994 Merton; Long-Term Capital Management 1998 LTCM; $4 billion LOSS! highly leveraged positions 1995 Nobel Prize; Scholes & Merton (Black’s option had expired)

You’ve come a long way, baby...

1975: American Stock Exchange (AMEX) 1975: Philadelphia Stock Exchange (PHE) 1976:Pacific Stock Exchange (PSE) 1976:Midwest Stock Exchange 1977: put trading at the CBOE begins 1979: reaches 35.4 million puts 1982: New York Stock Exchange 1983: Chicago Board Options Exchange

option w/underlying stock index; S&P 100 1999: open contracts almost 60 million 2000: International Stock Exchange (ISE)

The sky is the limit now...

Ask me no questions, I’ll tell ya no lies.