In early 1973, economists Myron S. Scholes and Fischer Black were trying to find a journal to publish the paper on options pricing they had been working on with Robert C. Merton, another young economist. Finally, the Journal of Political Economy accepted the paper, which was formally penned by Messrs. Scholes and Black, for its spring issue.
The timing couldn't have been better. Around the same time, a group of grain traders from the Chicago Board of Trade, along with a few transplanted New York options traders and former stockbrokers, was getting ready to open the Chicago Board Options Exchange, the first formal exchange where options could be traded. The new exchange standardized options strike prices and expiration dates, which helped organize what had been a scattershot approach to options trading.
Still, one key piece of the puzzle was missing: how to accurately price an option.
"From day one, when the CBOE started trading options, the one question traders had was: ‘What is it worth? What should it sell for?' " said Michael Schwartz, a managing director and options strategist at Oppenheimer & Co. Inc., New York. The price of options at that time was determined in large part by the broker's experience combined with the underlying stock's price.
But that method of pricing options didn't last long because the Journal of Political Economy was about to publish "The Pricing of Options and Corporate Liabilities," the paper by Messrs. Scholes and Black, which contained their formula for pricing options that became known as the Black-Scholes model.
The world of finance has not been the same since.