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Basics of Stock Options Timothy R. Mayes, Ph.D.FIN 3600: Chapter 15 Introduction Options are very old instruments, going back, perhaps, to the time of Thales the Milesian (c. 624 BC to c. 547 BC). Thales, according to Aristotle, purchased call options on the entire autumn olive harvest (or the use of the olive presses) and made a fortune. Joseph de la Vega (in “Confusión de Confusiones,” 1688, 104 years before the NYSE was founded under the buttonwood tree) also wrote about how options were dominating trading on the Amsterdam stock exchange. Dubofsky reports that options existed in ancient Greece and Rome, and that options were used during the tulipmania in Holland from 1624-1636. In the U.S., options were traded as early as the 1800’s and were available only as customized OTC products until the CBOE opened on April 26, 1973. What is an Option? A call option is a financial instrument that gives the buyer the right, but not the obligation, to purchase the underlying asset at a pre-specified price on or before a specified date A put option is a financial instrument that gives the buyer the right, but not the obligation, to sell the underlying asset at a pre-specified price on or before a specified date A call option is like a rain check. Suppose you spot an ad in the newspaper for an item you really want. By the time you get to the store, the item is sold out. However, the manager offers you a rain check to buy the product at the sale price when it is back in stock. You now hold a call option on the product with the strike price equal to the sale price and an intrinsic value equal to the difference between the regular and sale prices. Note that you do not have to use the rain check. You do so only at your own option. In fact, if the price of the product is lowered further before you return, you would let the rain check expire and buy the item at the lower price. Options are Contracts The option contract specifies: The underlying instrument The quantity to be