Equity and Index Options Explained

4

Option Uses

The ways in which options may be used were briefly outlined in the preface to this book. These possible uses will be expanded upon in this chapter but first it is worth considering the evolution of options.

Many people conceive of options as a relatively recent phenomenon; complex financial instruments traded by sophisticated traders in high-tech dealing rooms. In fact, options have been around for a very long time. It is likely that options have been traded since man first assigned values and prices to goods and assets; indeed, there is evidence that grain and metal options were traded by the Phoenicians as early as the second millennium BC. The driver behind this early option use was almost certainly hedging, a desire to guard against adverse price movements. Farmers have always been exposed to fluctuating crop prices; derivatives such as grain options developed as a way of managing this risk.

While hedging may be viewed as the “correct” or “true” use of options, the reason why options were “invented”, it is nonetheless true that options also offer tempting opportunities to speculators. In his book entitled Politics, Aristotle tells the story of Thales, the first known Greek philosopher, mathematician and scientist (thought, incidentally, to be the teacher of the better known Pythagoras). Thales is said to have anticipated a bumper olive harvest and therefore decided to take out options on all the olive presses in the region, which he was then able to rent out at ...