Around 350 B.C.E.
The first known option buyer in the world was the Greek mathematician Thales of Miletus.
One year he predicted that the season’s olive harvest would be much larger than usual.
During the growing season, Thales approached the owners of the presses and asked them to sell him the right to use the olive presses during the harvest season. Thales agreed to give the owners of the olive presses a small premium immediately, which the owners would keep either way, in order to lock in the right to use the presses for the next harvest at an agreed upon price.
The owners didn’t mind doing this as they would get a guaranteed amount either way and if Thales walked away from the deal, they would still be able to sell the rights to use the presses as they typically do each year.
He had bought a Call Option from the mill’s.
When spring came and the olive harvest was much larger than expected and since the harvest is time sensitive, the farmers in their desperation bid up how much they would pay the olive mill to process their harvest quickly.
Thales ‘exercised’ his options and rented the presses out at much higher price than he paid for his ‘option’, and made a fortune. One of the most notable uses of option contracts in history occurred during the tulip bulb bubble of 1637.
During the 1630s, tulip bulbs in Holland began to appreciate in value. In what was similar to the dot-com bubble of the late 1990s and early 2000s, people began to chase the price of tulip bulbs up to levels that were not sustainable or reasonable.
Options and futures became popular derivatives during this time for a couple of reasons: delayed delivery and leverage. Tulip dealers would plant bulbs which would not be ready for delivery or sale until sometime in the future. This created the perfect market for futures and options as the buyers, speculating that the price of bulbs in the future would be higher than when they were planted would enter into call contracts to purchase the bulbs at a specified price and at a future date in time. For this right, they would pay the seller of the bulb, a premium which the seller would keep regardless of the price of the bulb in the future.
Most speculators at this time would have used options because of the leverage. For a small amount of money, the premium, these speculators could enter into dozens, if not hundreds, of contracts in the hopes of selling those contracts later at a much higher price.
A bubble called ‘tulip mania’ appeared.
Eventually, the prices of the bulbs completely collapsed. Since the options and futures markets were not regulated as they are today, many of the buyers and sellers of the contracts simply walked away from their obligations.
Another notable event involved a Barings Bank employee. Nick Leeson was assigned to be the manager of the bank’s derivative operations in Singapore in 1992.
A typical trading strategy that Leeson was supposed to be employing was an arbitrage strategy between the Singapore Stock Exchange and the Japanese Stock Exchange.
For example, a trader could sell an option on one exchange and then buy the same type of option on the other exchange with the goal of profiting from the slight price ‘spread’ between the two exchanges.
This would be a low-risk, low-reward type of strategy but, if employed numerous times and managed effectively, it could still be quite profitable.
However, Leeson wasn’t always hedging his options positions and began to incur huge losses from his trading mistakes. Because of an internal oversight, Leeson was able to hide the losses from his employers in England, at least for awhile.
A large drop in the Nikkei after an earthquake caused Leeson’s options trading losses to hemorrhage. Barings Bank was declared insolvent on Feb. 26, 1995.
The losses that Leeson incurred were estimated at around $1.3 billion.
Options appear to have made their U.S.debut in what were described as “bucket shops”. The bucket shop in 1920s America was made famous by a man named Jesse Livermore.
Livermore speculated on stock price movements; he did not actually own the securities he was betting on, but merely predicted their future prices.
At the beginning of his career, he was basically a stock option bookie, taking the opposite side of anyone who thought a particular stock may increase or decrease in price.
If someone came to him speculating the stock of XYZ Company was going to go up, he would take the other side of the trade. (Jesse Livermore’s investing philosophy wasn’t foolproof, but he’s still recognized as one of the greatest traders in history.
To learn more, check out Jesse Livermore: Lessons From A Legendary Trader.
Most of the option trading prior to 1973 had been done by farmers and businesses seeking to hedge their agricultural exposure. Options were used in order to lock in prices for both selling and purchasing crops.
Before 1973, option buyers made individual contract agreements with option sellers. This made the option market highly chaotic as the terms for each contract would be different.
Once stock options were standardized, it meant that 1 contract = 100 shares of stock (although there are exceptions). In addition to the size of the contract, the expiration date and strike price were also standardized.
In 1973, the Chicago Board Options Exchange (CBOE) became the first U.S. exchange to trade listed stock options. The CBOE offered call-option trading on 16 different stocks. Before this, there was no exchange set up to match buyers and sellers of option contracts.
In 1975, the Securities and Exchange Commission enabled the Options Clearing Corporation (OCC) to serve as the central clearinghouse for all exchange-traded options.
Today Options are becoming very popular since you can participate in the Market, without owning the stock and it’s associated risk and with the right option strategy, you can almost guarantee a profitable trade.
A stock can only do 1 of 3 things: It can go up, it can go down, or it can remain the same.
With options you can profit on any 2 of those movements. Sometimes, (very rarely) on all 3.
The Rowboat strategy that I employ makes money if the stock goes up, stays the same, and can even go down a little. Of course, nothing is perfect. The Rowboat has been demonstrated to make money 96.4% of the time.
If you only risk 5% in each trade, it is almost like printing money, since you can’t lose more than you gain.
Until Next Time
The Options oracle.