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