ABOUT OPTIONS GENERALLY

On financial markets, options are financial derivatives that give the holder the right, but not the obligation, to buy or sell an underlying asset, such as shares, commodities, currencies or other financial instruments, at a price agreed in advance, within a specified period or on a set date. Options are key instruments on financial markets, enabling investors to speculate on future price movements or to hedge against potential risks.

There are two basic types of options:

  • Call Option (option to buy): gives the holder the right to buy the underlying asset at a price agreed in advance, within a specified period or on a set date.
  • Put option (option to sell): gives the holder the right to sell the underlying asset at a price agreed in advance, within a specified period or on a set date.

The value of options derives from the underlying asset to which they relate, which makes them derivatives, since their value depends on the price movements of that asset. Options allow investors to pursue different strategies, such as hedging, speculation or making a profit from changes in asset prices, with varying levels of risk.

LEGAL CHARACTERISTICS OF THE PUT OPTION

In relations between members of a company, a put option is a contractual right of a particular person to require the other contracting party, under conditions set in advance, to buy that person’s shares in a limited liability company or a joint stock company. The holder of the put option is not obliged to exercise the right, whereas the other contracting party, which has undertaken the obligation to buy, must act in accordance with the contract once the conditions for exercising the option are met.

The price at which the shares may be sold may be fixed in advance or determinable according to agreed criteria. Exercise of the put option may be tied to a specific period, the occurrence of agreed circumstances or other conditions defined in advance.

Put options are popular among investors who want an exit strategy, that is, to secure the right to sell their shares at a price agreed in advance. This strategy is useful if the company runs into difficulties, as the investor can sell its share and minimize losses.

For example, minority members of a limited liability company or minority shareholders of a joint stock company may use put options to secure the right to exit the company in the event of adverse changes, such as changes in the management structure or a takeover of the company.

In agreements between the founders of a company, put options may also be agreed as part of a strategy for resolving disagreements or enabling one of the founders to exit on favorable terms.

You can read about ways of agreeing the future price and its amount on the page dealing with the legal aspects of the call option.

In corporate negotiations, holding a put option can significantly strengthen the negotiating position of its holder. For example, in negotiations on a takeover of the company, minority members with an agreed right to sell can exit the company on terms set in advance, which reduces uncertainty about the future disposal of their shares.

As a contractual right to sell shares, the put option is not specifically regulated by the Serbian Companies Act. However, it may be agreed on the basis of the general rules of the law of obligations and the provisions of the Companies Act on the freedom of members to regulate their mutual relations, in particular Articles 15 and 140.

When agreeing and exercising a put option, account should be taken of the statutory rules on the transfer of shares, the right of pre-emption, any restrictions in the founding act and the prescribed form of the share transfer agreement.

The Capital Market Law may be relevant where a particular option qualifies as a financial instrument within the meaning of that law.

If you need to agree a put option or align it with the company’s founding act, see our contract drafting service.

ORIGIN OF AN OPTION AS A LEGAL INSTITUTE

The option, as a financial instrument, has a long history stretching over centuries, evolving from simple contractual arrangements into the sophisticated financial derivatives we know today. Understanding its legal origins requires an overview of the historical events and legal frameworks that shaped the use and regulation of “options” in general, which may also indirectly concern the put option.

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

This is considered one of the earliest known examples of the use of options in history.

Thales, the Greek philosopher and mathematician, reportedly concluded agreements that gave him the right (but not the obligation) to use olive presses ahead of an expected rich olive harvest, entering into them at a low price during the winter and making a profit when demand rose at harvest time.

This example is often cited as a historical illustration of the option mechanism, although it concerned the right to use olive presses, not the purchase of assets.

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

The option, as a financial instrument, has its roots in the development of derivatives markets, which began to take shape in the modern sense in the 17th century. In Amsterdam, trading developed in the 17th century in various instruments that were forerunners of modern financial derivatives, including forward contracts and options.

During the so-called “Tulip Mania” in the Netherlands (1636-1637), forward contracts for tulip bulbs were traded, while some contractual arrangements also had features similar to today’s options.

These contracts were not formally regulated.

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

Development of Options Trading in Great Britain (18th and 19th Centuries):

As early as the 18th century, various forms of contracts for the future purchase and sale of securities, including option contracts, were used in London. The modern London Stock Exchange was established at the beginning of the 19th century.

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

The British government periodically tried to prohibit or restrict trading in these instruments because of their speculative nature.

20th Century – Formalization and Regulation

The founding of the Chicago Board Options Exchange (CBOE) in 1973 was a key moment in the history of options in general.

The CBOE was the first official exchange specialized in trading standardized stock options. Trading in standardized put options on that exchange began in 1977.

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

This formalization enabled wider use of options as legitimate financial instruments and encouraged the development of sophisticated derivatives markets.

Regulation in the United States:

Securities Act of 1933 and Securities Exchange Act of 1934: these laws laid the foundations of US securities market regulation, which was later developed in relation to options trading as well.

Commodity Futures Trading Commission (CFTC): established in 1974, this agency is responsible for regulating derivatives markets, including futures and certain 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 the regulation of derivatives markets, requiring greater transparency and reducing systemic risks.

Trading in standardized options in the US developed within a special regulatory system for financial instrument markets, under the supervision of the competent regulators. In the United States, options trading is supervised by the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC).

See also: Call option, Tag-along rights, Drag-along rights

This text does not constitute legal advice and is for information purposes only, in accordance with the terms of use of this website.