Story of the first option

Finance is difficult, right? You would think that you need fancy college degrees to understand finance. But we see many examples today that cool school ≠ career success. But you would be amazed how old the instances of use of modern financial tools are.

Take derivatives for example. Though not called by same fancy names as today, derivatives have been around a long, long time. So, let’s talk about the first instance when a derivative was used as per us modern humans.

If you look around in catalogues of google info, you will find that the people wearing pants started derivative trading in the 1800s in the US. The demand for agricultural produce was high which gave rise to forward delivery contracts at The Chicago Board of Trade (now the CME group). Futures came in around 1865 and in 1970s, options trading became popular.

But before there was Chicago, before there were pants and before there was even Christ, there was Thales of Miletus. And he can possibly be credited with executing world’s first call option trade.

Thales was a mathematician and an astronomer who lived in Greece around 624/623-548/545 BC. Now he was a Greek so of course he was a philosopher. In fact, he was one of the Seven sages of Greece. He proposed water as the first element, contributed to various mathematical theorems and described the position of Ursa Minor.

But he became famous when he pulled off the feat of predicting the solar eclipse of May 28, 585 BC with the help of his theorems and astrology practices. However, from amidst all the cheering and hooting, there came a question, loosely translated

“How come you’re so smart and still so poor?”

And thus, he set out to prove to that one random stranger and the world that philosophy can be used practically to make riches. Now he was poor, so he had to find a way to make a lot of money with little investment. And that’s when he came across olives. Olives and olive oil held special place in ancient Greece. Described as ‘liquid gold’ by Homer, olive oil was used not just for consumption and cooking but also as perfume and in religious ceremonies.

Every year, thousands of Greek farmers produced olives and then rented olive presses to turn the perishable olives into not so perishable olive oil. Thales put his smart boy glasses on and started analyzing various factors that contributed to an ample weather for olive harvest. And when he was done, he concluded that the harvest would be bumper this year because of favorable weather.

This in turn would increase the demand of presses as farmers needed to save their harvest. So, Thales started visiting the olive press owners with a proposition. He will give them a small cash deposit in advance if they agree to rent the press to him at fixed prices when he comes calling during the harvest season. If he doesn’t come, they can keep his cash and rent the press to someone else. And this people, is what we know as Call option today.

The press owners were accustomed to renting out their assets as this avoided them the labor of making the oil, discarding the residue, and marketing the produce. And without paying much heed to an old scholar, they thought they were taking his lunch money. Their answer was yes.

Days went by and what Thales predicted came to pass. Streets were jammed with wagons filled with fresh berries. Everyone was looking for a press to make oil. But owners couldn’t rent them out because an old man held the rights to rent. And the old man did… well absolutely nothing. He waited and waited until fear and frenzy made everyone restless. And then he rented out the press to the highest bidder, turning his small cash deposits into a fortune. Had he been wrong, his loss would have been limited to the deposits. This is the essence of a call option.

The press owners thought that they were pawning off their risk in advance. But essentially, they had foregone their chance to make unlimited profits as well. To contextualize how much profit Thales made, Greece produced 300 million tons of olive oil last year. If Thales had sub leased the press for even 10 shekels per ton, he would have become Shekel billionaire three times over.

So, even though the candles on the screen have come into picture recently, the concepts of finance have been with us since the dawn of humanity.