and clearing memberships were authorized for sale on the new exchange and clearinghouse .
Success Brings Competition
In its initial approval order , the SEC held Cboe on a tight leash , allowing only call options trading on no more than 20 underlying stocks . Despite these limitations , trading volume soon far exceeded projections . If imitation is said to be the sincerest form of flattery , it didn ’ t take long before Cboe had competitors to contend with as the American Stock Exchange ( Amex ), Philadelphia Stock Exchange , Midwest Stock Exchange and Pacific Stock Exchange all applied for , and received , SEC approval in the ensuing months to enter the listed options business . The New York Stock Exchange ( NYSE ) and Nasdaq remained on the sidelines for a few years before starting options trading .
Amex was the second exchange to start an options market and was prepared to create its own clearing organization . That proposal was not well-received by the brokerage firm community , which sought to avoid multiple clearing entities . They reached a resolution when Amex negotiated to buy a 50 % interest in Cboe ’ s existing clearing arm , which was then renamed The Options Clearing Corporation ( OCC ). As other exchanges prepared to start their options programs , each purchased an ownership interest in OCC .
The concept that a single options clearinghouse would serve as the issuer and guarantor of all listed options contracts was a crucial innovation that helped ensure the success of options trading in the United States . With OCC serving as the opposite party to all options transactions — the buyer for every options writer , and the writer for every buyer — it became possible for market participants to enter into trades without investigating the creditworthiness of the opposite party or worrying that the opposite party might default .
For buyers of exchange-listed options , the existence of a secondary market meant that those buyers could liquidate ( close out ) their long positions by entering a “ closing sale transaction .” Similarly , for option writers , the existence of a secondary market substantially increased their flexibility as they could also eliminate ( close out ) their contractual liability at any time prior to expiration by purchasing
Cboe Global Markets
Options traders in the early days of the Cboe , 1975 .
options with identical terms to the ones previously sold , in a “ closing purchase transaction .” This combination of interchangeability of options and the severance of direct links between options buyers and writers fostered the growth of an active , liquid secondary market and has been primarily responsible for the success of the listed option concept .
Another reason often cited for the growth and popularity of exchange-listed options trading was the standardization of terms for all traded option contracts . At its core , an option covering 100 shares of a particular underlying stock has three basic characteristics : a maturity ( expiration date ), a strike ( exercise ) price and a premium ( the price at which the option trades ). In the OTC market , each of these characteristics can vary from contract to contract . This contrasts with the listed options framework where the maturities and strike prices are standardized , with only the premium remaining variable to reflect changes in future price movements of the underlying shares .
Having limited Cboe to listing options on not more than 20 underlying stocks , the SEC continued this practice as additional exchanges were approved for options trading . Before expanding the number of listings , exchanges had to satisfy the SEC as to their operational efficiency . The SEC also required any underlying stock considered for options trading to be either NYSE or Amex-listed .
During the 20-month period before Amex started its options program , Cboe was the only options exchange and enjoyed free reign to select any qualified underlying stock for options trading . However , once the Amex and other exchanges entered the business , it was inevitable that more than one exchange might seek to select the same underlying stock . Just that scenario occurred in 1976 when the Cboe and Amex both selected and began trading options on the common stock of MGIC Corporation . It became the first multiply-traded ( dual listed ) option and the start of many hotly contested trading battles among the options exchanges which increased in intensity once the SEC permitted listed options trading on popular Nasdaq and foreign stocks .
Competition among the options exchanges yielded certain beneficial changes . This included guaranteed prices for certain size orders ( minimum 10 contracts ), enhanced order entry systems and a general tightening ( narrowing ) of price quotes between bids and offers . In 1977 , with four years of options trading experience limited to call options , the SEC allowed for a pilot program to introduce puts to the markets . Overall , interest in options grew each year as more retail , professional and institutional customers became attracted to the markets .
A Lawsuit and a Moratorium Threaten Growth
In late July 1983 , with more than 10 years of listed options trading completed , an interesting development occurred following the Amex ’ s announcement of its intention to commence options trading on the common stock of Golden Nugget , a popular and actively traded NYSE listed company . Ever since its 1973 approval for Cboe to start options trading , the SEC never required an options exchange to secure the consent of an underlying stock before commencing options trading . The SEC ’ s position was that any options that would be created once trading commenced would be issued by OCC and not the underlying company . Provided an underlying stock met existing options listing criteria , the exchanges were free to trade options on that stock .
www . MoAF . org | Spring 2023 | FINANCIAL HISTORY 21