Along with futures, options are some of the most traded derivative instruments. In the first quarter of 2020, as the markets went into a tailspin due to the looming threat of the pandemic, close to five billion options contracts changed hands on global derivatives exchanges, up 40% from the same period in the previous year. They’re commonly used as a hedging tool, allowing traders the opportunity to spread their risk against both sides of a position.
But despite being a staple feature of Wall Street, options didn’t originate there. What’s more, thanks to DeFi and tokenization, their future is unlikely to remain there, either.
The History of Options
The first-ever use of an options contract is thought to date back to Ancient Greece. The story goes that philosopher and mathematician Thales of Miletus used his knowledge and understanding of the Greek climate to predict that there would be a bountiful harvest of olives in one particular year. He went to all the operators of olive presses in Miletus and gave them a down payment for the right to use them when the harvests came in.
When his prediction proved correct, he rented out the presses at a premium price due to high demand. Effectively, Thales had entered into the first-ever version of a call option.
Options came up again throughout history, during the “tulip mania” of 1636 and in seventeenth-century London when the markets started to formalize. In 1920’s America, options were one instrument used by so-called “bucket shops,” essentially illegal bookmakers, that allowed traders to speculate on stock prices.
However, it wasn’t until the 1970s that options trading was formalized into the business as we know it today. The Chicago Board Options Exchange was set up in 1973 to trade standardized call options, with put options introduced in 1977.
Over recent decades, there haven’t been any significant developments in options trading until the emergence of cryptocurrencies, and more recently, DeFi. Deribit was the first exchange to launch European vanilla options backed by Bitcoin and Ether, but now the crypto options market is growing rapidly. In the last six months alone, open interest in BTC options has grown from around $2 billion to a recent high of around $14.5 billion.
However, the biggest strides are in the DeFi options markets. Early pioneers such as Hegic and Potion introduced the concept of tokenized options traded in pools. However, the recent launch of Premia Finance is worth noting in any discussion about the development of options trading. It marks the first time that users can mint and trade tokenized options in a peer-to-peer way.
Premia enables this thanks to the use of ERC1155, which allows the protocol to add support for any token to its marketplace via a single multisig submitted transaction. Bypassing the need to implement a new contract for each new token avoids Ethereum’s high transaction costs, offering a more efficient and cost-effective way to create options.
Therefore, Premia offers users the opportunity for complete customization and flexible asset selection so that they can create and trade options of any strike price, any expiration date, and any supported token. Via the interface, users can choose to mint options to their own wallet or for sale on the Premia marketplace. They can also trade already-minted options on the Premia secondary markets. Along with Ethereum-based assets, the protocol also supports tokens issued on the Binance Smart Chain.
The Future of Options
The availability of decentralized, non-custodial, peer-to-peer tokenized options trading paves the way for a future where options trading is more flexible and democratic. Tokenized options in DeFi are currently focused on digital assets. Still, there is no reason why, in the future, tokenized options shouldn’t be backed by any assets, such as stocks, bonds, commodities, forex pairs, or any other items of value.
Until now, options have been mostly the preserve of professional traders and institutions. However, tokenized options traded peer-to-peer could open up the markets to new audiences of traders. For instance, long-term retail investors who want to hedge their retirement funds against future market volatility. Such as shift would bring new liquidity into options markets, as well as increasing their value.
It’s not often that there’s a seismic shift in the relatively staid financial markets, but the shift to digital trading and the emergence of digital assets were both precursors to the DeFi revolution that’s still unfolding. In the years to come, options trading will shift to being fully tokenized, thanks to the projects blazing a trail today.