Why were options created?

[robots]

hello,

why were options over stocks, indices etc created?


thankyou

robots

 

[RichKid]

hello,

why were options over stocks, indices etc created?


thankyou

robots

Hi Robots,

Great question!

My guess is to help manage exposure to risk. Whether it be movements in market prices or the weather or maybe I'm mixing that up with futures (which carry an obligation as opposed to options which don't oblige you to buy or sell).

In the early days option contracts would have related to goods and produce but now it includes pure financial products too (eg to protect a share portfolio or other investment).

I've been told that large instos use derivatives to 'sell' their risk to us mug punters.

I bet the ASF options buffs would have some fascinating historical material to share with us....over to you folk!!

 

[RichKid]

Did a quick google, interesting stuff:

A Brief History of Options:
Options in the Ancient World

An applied mathematician called Thales (624-547 BC) may have been one of the first people to get rich by trading options.

Thales lived in the Greek city of Miletus, situated on the southwest coast of what is now Turkey. He was one of the first Greek scientists, and one of the founders of a group of thinkers later called the preSocratics.

Thales was celebrated for his successful prediction of the solar eclipse which occurred on 28 May in 585 BC, and for his skills in astronomy and navigation. He also became famous for getting rich by speculating in options!

According to Aristotle,

There is an anecdote of Thales the Milesian and his financial device, which involves a principle of universal application, but which is attributable to him on account of his reputation for wisdom. He was reproached for his poverty, which was supposed to show that philosophy was no use. According to the story, he knew by his skill in the stars while it was yet winter that there would be a great harvest of olives in the coming year, so, having little money, he gave deposits for the use of all the olive presses in Chios and Miletus, which he hired at a low price becasue no one bid against him. When the harvest time came, and many wanted them all at once and of a sudden, he let them out at any rate which he pleased, and made a quantity of money. Thus, he showed the world that philosophers can easily be rich if they like ...

(This passage is taken from Chapter 11, Book 1 of Aristotle's "Politics" as translated by Jowett and quoted in Luenberger's book Investment Science. I suspect that in a more modern translation, the word "philosopher" would probably be replaced by "applied mathematician"!)

It is likely that options and futures contracts were used in Africa up to 1000 years before the birth of Thales.


Derivatives in 17th Century Holland

Tulip mania swept Holland in about 1600, with very high prices paid for beautiful tulips and tulip bulbs. Growers bought put options and sold futures contracts in order to make sure they would receive good prices for their bulbs, andtulip retailers bought call options and futures to protect themselves against sudden prices rises by their suppliers. However the market was not regulated and crashed dramatically in February 1637 after months of frenzied trading and outrageously high prices. (For a full account, see Tulipmania by Mike Dash (Gollancz 1999).)


The Last 100 Years

Options on shares were traded on the London Stock Exchange more than 100 years ago. These were contracts between the buyer and seller, with no obligations on the part of the exchange itself. Similar instruments began to be used in other financial centres, most notably New York, and were developed and refined over the years.

In 1973, two important events occurred:

* The opening of the world's first formalised options market, the Chicago Board Options Exchange. For the first time, the exchange itself became a party to the contracts rather than just the venue where the contracts were negotiated. This idea quickly spread to a number of other markets.

* A paper published by Fischer Black and Myron Scholes (Journal of Political Economy, 81 pp 637-654) provided the first reasonable mathematical model for the pricing of options.

Since 1973, interest has exploded, with an enormous variety of options being traded in exchanges all over the world.

Hugh Luckock
Last modified: Fri Nov 3 15:44:13 EST 2000 http://www.maths.usyd.edu.au/u/hughl/Financial_Mathematics/history.html (this academic has more technical securities and finance material on his site, very technical- you have been warned!)

Also a brief overview here:

http://www.optionsxpress.com/educate/investing101/history.aspx

So, the challenge for the next poster is to find an authoritative article on options/futures trading in ancient Africa! On your marks, get set, go!!!....and they're off...

They say that Africa is the birthplace of civilization, looks like the birthplace of financial instruments as well!