ABOUT OPTIONS GENERALLY

In a broader sense, options are financial derivatives that give the holder the right, but not the obligation, to buy or sell an underlying asset, such as stocks, commodities, currencies, or other financial instruments, at a predetermined price within a specified time period. Options are key instruments in financial markets, allowing investors to speculate on future price movements or hedge against potential risks.

There are two main types of options:    

  • Call Option : Provides the holder with the right to buy the underlying asset at a predetermined price within a specified period.
  • Put option: Provides the holder with the right to sell the underlying asset at a predetermined price within a specified period.

             The value of options derives from the underlying asset to which they relate, making options derivatives since their value depends on the price movement of that underlying asset. Options enable investors to employ various strategies, such as hedging, speculation, or profit from price changes in the asset, with controlled risk.          

LEGAL CHARACTERISTICS OF THE PUT OPTION

A put option is a legal institute or financial derivative that grants the holder the right, but not the obligation, to sell a specified amount of the underlying asset, such as stocks/shares, at a predetermined price (known as the strike or exercise price) within a specified time period. The put option is the counterpart to the call option, which grants the right to purchase the asset.

Thus, the owner of a put option has the right to sell the underlying asset at the agreed price but is not obligated to do so. If the market price of the underlying asset falls below the strike price, the holder can realize a profit by selling at the higher price guaranteed by the option. If the asset price remains above the strike price, the holder may choose not to exercise the option, thus losing only the premium paid for the option.

Put options are popular among investors seeking an exit strategy or wanting to secure the right to sell their stakes in a company at a predetermined price. This strategy is beneficial in scenarios where the company faces issues, as the investor can sell their stake and minimize losses.

For example, minority shareholders in a company can use put options to ensure the right to exit the company in case of adverse changes, such as alterations in the management structure or a company takeover.

In founder agreements, put options can be negotiated as part of a strategy to resolve disputes or to allow one of the founders to exit under favorable conditions.

For information on how to negotiate the future price and its amount, you can read the page concerning the legal aspects of the call option .

In corporate negotiations, holding a put option can significantly strengthen the negotiating position of the party holding the option. For instance, in situations where a company takeover is being negotiated, minority shareholders holding put options can retain control over the terms under which they will sell their stake, ensuring they receive fair compensation for their share in the company.

In the Republic of Serbia, the put option is not specifically regulated by the Companies Act; instead, this regulation is applied indirectly, while general provisions of the Law of Contract and Torts also applies. Additionally, depending on the legal form of the company, the Capital Market Act may also be applicable.

ORIGIN OF AN OPTION AS A LEGAL INSTITUTE

The option, as a financial instrument, has a long history extending through the centuries, evolving from simple contractual arrangements to the sophisticated financial derivatives known today. Understanding its legal origin requires a review of historical events and legal frameworks that have shaped the use and regulation of “options” in general, which can indirectly relate to call options as well.

Ancient Beginnings – Thales of Miletus (6th Century BC):

Considered one of the earliest known examples of use of an option in history.

Thales, a Greek philosopher and mathematician, is said to have entered into contracts that gave him the right (but not the obligation) to use olive presses ahead of an impending rich olive harvest, concluding contracts at low prices during the winter and realizing a profit when demand rose in the spring.

This example illustrates the basic concept of a call option, where the option holder gains the right to purchase an asset at a predetermined price in the future.

17th Century – Netherlands and Tulip Mania (1636-1637):        

Call options, as a financial instrument, have roots in the development of derivative markets, which began to take shape in a modern sense in the 17th century. The first documented derivative market dates back to Amsterdam, where traders engaged in futures contracts and similar forms of derivatives, including options.

During the period of the so-called “Tulip Mania” in the Netherlands, derivative instruments similar to today’s options were traded on tulip bulbs.

Contracts allowed buyers the right to purchase or sell tulip bulbs at a certain price in the future, representing a precursor to modern call and put options.

These contracts were not formally regulated and often led to speculative bubbles and financial losses, highlighting the need for derivative market regulation.

18th and 19th Centuries – Development in Great Britain and the United States

London Stock Exchange (18th Century):

Traders began using options contracts for trading stocks and commodities.

These early forms of options were often informal and poorly regulated, leading to manipulation and financial scandals.

The British government periodically attempted to ban or restrict trade with these instruments due to their speculative nature.

20th Century – Formalization and Regulation   

The establishment of the Chicago Board Options Exchange (CBOE) in 1973 represents a key moment in the history of call options and options in general.

The CBOE was the first official exchange specialized in trading standardized stock options.

The introduction of standardized contracts and a centralized clearing house (Options Clearing Corporation – OCC) increased transparency and reduced the risk of default.

This formalization allowed for the broader use of options as legitimate financial instruments and spurred the development of sophisticated derivative markets.

Regulation in the United States:

Securities Act of 1933 and Securities Exchange Act of 1934: These laws laid the groundwork for securities regulation, including derivative instruments.

Commodity Futures Trading Commission (CFTC): Established in 1974, this agency is responsible for regulating derivative markets, including futures and some types of options.

Securities and Exchange Commission (SEC): Regulates trading in stock options and other securities, ensuring investor protection and market integrity.

Dodd-Frank Wall Street Reform and Consumer Protection Act (2010): Following the 2008 financial crisis, this law tightened regulation of derivative markets, requiring greater transparency and reducing systemic risks.

Thus, call options have been legally formalized in the US through contracts regulated by general rules of contract law. In the United States, options trading is overseen by the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC).

 

This text is for informational purposes only and does not constitute legal advice in accordance with the terms of use of this web presentation.