Options Before Quants
Today options and investing with options means quant models, debates over how to measure implied volatility, or strategies to trade futures on the VIX. This modern era in options began in 1973 with the publication of Black-Scholes,1 the first practical theory about options prices. But of course, options didn’t begin with Black-Scholes; some argue that both Greek mythology and the Bible include discussions or at least allusions to options trades. Sticking to written historical records and options similar to current ones, options history can easily reach back to the early 1600s in Amsterdam.
At that time, Amsterdam was the leading European financial center, and the center of innovation. In 1602, the Dutch East India Company was the first stockholder-owned corporation listed with shares that could be traded and held by people not otherwise linked to the company. While trading was active, settlement procedures were monthly, and recording ownership on the company’s books was more complex than today.
Though electronic trading was four centuries in the future, the market was sophisticated and experienced in trading equities, commodities and fixed-income instruments. Options—both puts and calls—on Dutch East India Company stock were actively traded as well.2,3 If the Amsterdam market in this historical context rings a bell for readers, remember that it is the same market that would experience a bubble in tulip bulbs in 1634-37—a bubble built on options and futures, not the cash market.
Options trading without quantitative pricing models thrived. Research depended on a combination of technical and fundamental analysis. The latter included information regarding the local economy where the Dutch East India Company’s ships would be delivering their cargos; reports of economic conditions in India and South Asia where the ships bought and loaded cargos; and rumors of sailing and weather conditions, shipwrecks and other hazards. Options trading was supported by two factors: 1) with limited information, many investors preferred options to stocks because the downside risks could be limited; and 2) the share price for the Dutch East India Company was high, and options were a way to invest without risking too large a proportion of one’s wealth.