This was the case before they managed to standardize option trading through the use of the Black Scholes option pricing model.
CBOE
Founded by the Chicago Board of Trade in 1973 and member-owned for several decades, the Chicago Board Options Exchange was the first exchange to list standardized, exchange-traded stock options, and began its first day of trading on April 26, 1973, in celebration of the 125th birthday of the Chicago Board of Trade.[3] In 1969, the vice chairman of the Chicago Board of Trade, Edmund “Eddie” O’Connor, developed the idea for an options exchange.[4] At that time, options on stocks were traded in a New York-based,[5] over-the-counter market which required a direct link between the buyer and seller and complex terms of sale.[6] The options exchange that O’Connor imagined would use a central clearinghouse to facilitate trades and stand behind contracts.[6] The Chicago Board of Trade established a committee to evaluate the concept.[7]
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I’ve been following this discussion. The answer lies in ignoring the incidentals, like the market makers and concentrating of the option premium.
The option premium has two components:
- Time value is a depreciating asset that goes to zero at the market close on the expiration date. It is very volatile depending on the underlying stock’s volatility. It is a zero sum game because the seller makes what the buyer pays.
- Intrinsic value is the difference between the underlying stock’s price and the option’s strike price. This is the confusing part. When you buy a call you buy the right to buy the stock at the strike price. You buy the right to pay the intrinsic value. The call seller is selling the right to the intrinsic value. This is also a zero sum game, one party gets the intrinsic value the other party loses it.
The complication is the value of the asset the seller is using to back the call he is selling, but, is that part of the option game? Not so in my opinion but certainly an important consideration in the player’s option trader’s strategy. Selling calls have two alternative,
- Covered calls What is the value of the stock the sellers puts up as the security? The street price of the stock at the moment he sells the call. The price he paid is irrelevant to the option game itself even if it is an added risk for the seller.
- Cash secured calls The stock broker has control over the seller’s cash in the amount of the underlying stock’s street price.
In effect there is no difference making option trading a zero sum game. What varies is the risk profile for the players but that’s not part of the options game itself. This is what I mean by “ignoring the incidentals.”
The Captain