The Ancient Trading Tool You Can Profit From Today…

Here at Street Authority, we’re a bunch of history buffs.

A while ago, we read an academic paper about the origin and history of options that was just fascinating.

Of course, the paper offered no actionable trading advice. What it did offer was a rare insight and further proof of something we’ve been saying for years:

Forget what you think you know about options. They do not have to be particularly complicated or risky.

In the paper that we read, the author traced the history of options trading all the way back to ancient Greece. He cited boat insurance, known more formally as “bottomry loans,” as the first examples of options contracts.

The Forgotten History of Options

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Greek mathematician and philosopher Thales of Miletus has been said to be one of the first option traders.

Bottomry loans were made to merchants and shipowners to finance the transportation of goods between different ports. Lenders would fund the voyage and, if the voyage was successful, the shipowner would repay the lender, with interest. If the ship or its cargo was lost, the money lent to the shipowner would be a 100% loss.

Bottomry loans weren’t true loans because the lender accepted 100% of the voyage’s risk. They weren’t equity, either, because the return of the loan was fixed and known when the two sides completed the transaction.

Technically, this is economically equivalent to an option written by the ship’s owner. If the ship returned, the option had value and paid out a fixed amount. If the ship was lost, the option writer (shipowner) kept the premium and the option was worthless.

This type of option has existed for centuries, although options in stocks are a more recent innovation. They date back to the Amsterdam exchange in the 1600s. A market for options in the Dutch East India Co. developed, and these contracts spread to other markets.

The fact that these contracts existed means traders had to have some sort of pricing model. It looks like the first formal models were developed in the late 1800s. Amazingly, these models were actually similar to the ones we use today.

Contracts were simpler in the 1800s because they could be exercised only on the expiration date. In practice, modern-day contracts will be exercised only at expiration except in rare instances when it makes economic sense to exercise prior to expiration. However, the pricing models we use today must account for the remote possibility of early exercise.

Traders in the 1800s used the average price changes over the recent past to price the option. This was a rough measure of a stock’s volatility. They assumed the future, short-term volatility would be similar to the historic volatility. Our current models use more sophisticated math, relying on variance and standard deviations rather than averages, but the basic idea is the same. We use data from the past to forecast the likely trend in the future.

The Bottom Line

Given the long history of options, we have often wondered why they aren’t more widely used by individual investors. It could be because of the math, which is complex but not insurmountable. After all, traders in the 19th century were doing “options math” before the invention of computers or even digital calculators.

The point is that options have been around in some form or another for a long, long time. Options have proven they can adapt to changing markets. If they couldn’t adapt and continue to serve a need, they would no longer be traded.

The takeaway for you should be this: Don’t make the mistake of assuming that options serve the needs of only sophisticated traders and Wall Street gurus.

That’s exactly what they want you to think. The truth is that many individual investors and traders use options every day — and so can you. Whether your purpose is for speculation, hedging, income, or some combination of that, the reality is that you can make options as easy or as complicated as you wish.

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