The use of options in an attempt to ensure economic security or financial
gain dates back in our history much farther than most people would
expect. The first published account of options use was in Aristotle's
Politics, published in 332 B.C. According to Aristotle, Thales, a fellow
philosopher, was said to be the creator of options. Thales was not only a
great philosopher but also a great astronomer and mathematician. In
response to criticism that his profession had no merit, Thales used his
ability to read the stars in order to forecast future weather patterns. His
skill enabled him to predict a large olive harvest in the coming year.
Thales, however, had little money and was unable to secure the use of
the olive presses for their full value, so he put deposits on all of the
presses that existed for miles and miles. In doing so, he used a small
amount ofmoney to secure the right to use the presses come harvest season.
When olive-picking time came around and the presses were in great
demand, Thales was able to sell his options for a great deal more than he
paid for them. Unknowingly, perhaps, Thales had created the first option
contract. He purchased the right to use the presses, not the presses them~
selves. In doing so, he was able to use considerably less money than he
would have if he purchased the presses themselves. Owning the right
gave Thales the ability to use the presses during harvest time himself (or
to sell his options when, due to the demand, they would be worth considerably
more than when he entered the contract). The seller, on the other
hand, was happy to sell the right to use the presses, because it ensured
that the seller would receive income whether the harvest was successful
or not. In securing a price for the presses, however, the seller gave up the
right to charge the customers more for use ofthe presses during a record
harvest. Thales' foresight enabled him to reap this benefit. Clearly, then,
Thales was able to redeem philosophy and astronomy from any accusations
that its practitioners had their heads in the clouds.
Options sprang up again during the tulip mania of 1636. Tulips were
first imported into Europe from Turkey in the 1500s. These brightly colored
flowers gained in popularit)T, and the demand increased for all types
of bulbs. By the early 17th century; tulips had become a symbol of afflu...
ence; demand began to outweigh supply; and tulip bulb prices rose dramaticall)
T. As popularity increased to include all levels of society, Dutch
growers and dealers (with Holland being the largest producer of tulip
bulbs) began to trade tulip bulb options. With options being less expensive
than the direct purchase ofthe bulbs, greater numbers ofpeople speculated
on future price increases. Initiall~ this strategy proved profitable, because
prices did continue to rise. This situation only caused the speculative frenzy
to grow. People mortgaged their homes and businesses in order to cash in
on the free money: Tulip bulb prices continued to soar even higher.
The bubble burst in 1637.As prices dropped, the buying frenzy became
a selling panic. The Dutch economy began to crumble. People lost their
homes and their livelihoods, banks failed, and fortunes were lost. Although
the real causes of this financial fiasco were greed, reckless speculation,
and the use of borrowed funds to invest, people blamed options. This was
the first public black eye for options, because tulip options were responsible
for enabling people to speculate with small amounts of money and
large amounts of leverage. We must remember, then, that leverage can
work against a trader just as easily as it can work to his or her favor.
In 1872, an American financier named Russell Sage invented the first
call and put stock options. Like today's options, Sage's options gave the
holder the right to purchase (call) or sell (put) a set amount of stock at a
set price within a given time period. Sage began trading options in an
over-the-counter (OTC) fashion and made millions of dollars in the
process. These options were not standardized, and each contract had specific
characteristics that made them difficult to trade out of once they
were entered into. For this reason, it was unlikely that anyone aside from
the original buyer/seller would trade out of the contract with the option
holder. Furthermore, because the public was unfamiliar with stock
options, Sage was able to use them to manipulate securities-taking large
positions in the underlying stock without the knowledge of the public or
the company: At one point, by using stock options to manipulate the security,
Sage purchased such a large amount of a company's stock through
the use of options that he gained control of the New York City elevated
transit lines. After losing a great deal ofmoney by trading options during
the stock market crash of 1884, however, Sage stopped trading options
altogether. Yet, options continued to trade without him.
Read More: History of Options
