8  •   The Intelligent Option Investor
risk of default by one’s counterparty, so they are usually only entered into 
after both parties have fully assessed the creditworthiness of the other. 
Obviously, individual investors—who might simply want to speculate on 
the value of an underlying stock or exchange-traded fund (ETF)—cannot 
spend the time doing a credit check on every counterparty with whom 
they might do business.
1 Without a way to make sure that both parties are 
financially able to keep up their half of the option bargain, public option 
markets simply could not exist.
The modern solution to this quandary is that of the central counter -
party. This is an organization that standardizes the terms of the option con-
tracts transacted and ensures the financial fulfillment of the participating 
counterparties. Central counterparties are associated with securities 
exchanges and regulate the parties with which they deal. They set rules 
regarding collateral that must be placed in escrow before a transaction 
can be made and request additional funds if market price changes cause 
a counterparty’s account to become undercollateralized. In the United 
States, the central counterparty for options transactions is the Options 
Clearing Corporation (OCC). The OCC is an offshoot of the oldest option 
exchange, the Chicago Board Option Exchange (CBOE).
In the early 1970s, the CBOE itself began as an offshoot of a large 
futures exchange—the Chicago Mercantile Exchange—and subsequently 
started the process of standardizing option contracts (i.e., specifying the 
exact per-contract quantity and quality of the underlying good and the 
expiration date of the contract) and building the other infrastructure and 
regulatory framework necessary to create and manage a public market. 
Although market infrastructure and mechanics are very important for 
the brokers and other professional participants in the options market, 
most aspects are not terribly important from an investor’s point of view  
(the things that are—such as margin—will be discussed in detail later in 
this book). The one thing an investor must know is simply that the option 
market is transparent, well regulated, and secure. Those of you who have a 
bit of extra time and want to learn more about market mechanics should 
take a look through the information on the CBOE’s and OCC’s websites.
Listing of option contracts on the CBOE meant that investors needed 
to have a sense for what a fair price for an option was. Three academics, 
Fischer Black, Myron Scholes, and Robert Merton, were responsible for