Abstract

We show in this paper that option traders in the early twentieth century were able to intuit ‘fair’ value well before the advent of Black Scholes Merton-type (BSM) pricing models. Previous studies of early option price data disagree as to whether pre-1973 traders incorporated modern understandings of options valuations. Kairys and Valero (1997) claim they did not, whilst Mixon (2009) and Moore and Juh (2006) conclude that many elements of modern models are revealed in the scant records of early option trading. None of these three studies find that historical options prices were approximately BSM efficient. Our study of metal options traded in London in the 1920s and 1930s by John Maynard Keynes concludes that prices were remarkably close to BSM -efficient. The level of mispricing we observe is not out of line with more sophisticated derivative markets today. Not only did Keynes’ option traded prices approximate BSM levels, but these prices were as sensitive to changes in the key BSM valuation parameter, forecast volatility, as they are in today’s markets. Although BSM was undoubtedly a better measure of value than the heuristics previously employed in early 20th century options markets, we conclude that options were nonetheless efficiently priced even before this important innovation.