A Brief History of OptionsOptions: What are we talking about?Thales of Miletus, 624?–546? BCFrom just one man... 1593-1637What the heck is a guilder?A rose is a rose, but a tulip is something elseAll this for a flower?Wanna buy a cat in a bag?Harvest the WindHow did we get here?The Colossus topples...“Mr. Wizard, bring me home!”The mouse that roared...How did the mouse get in the house?Black-Scholes or Black Holes?You’ve come a long way, baby...The sky is the limit now...A Brief History of OptionsTom LePageOptions: 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 optionThales 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 pleasedFrom 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 VarietyWhat 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, 16371598 GuilderA 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 thenAll 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 1636Wanna 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” phaseHarvest 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, 1637How 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 contractsThe 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 exchangesHow 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 paymentsBlack-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: