How Black-Scholes Shaped Trading for the Past 50 Years

Fifty years ago, the world of trading was changed forever with a simple mathematical equation: the Black-Scholes(-Merton) option pricing model. The Black-Scholes equation allowed both investors and traders to shift from a linear payoff structure to a complex nonlinear payoff structure. Most academic articles celebrating this anniversary likely will focus on the mathematical equations that evolved from Black-Scholes—but ignore its effect on the trading community. Before Black-Scholes, options were exotic contracts sold in limited quantities. The Chicago Board Options Exchange was formed which started the modern trading of options almost simultaneously the Black-Scholes formula was acknowledged by the SEC. Option market making originally started as local traders (locals) trading in the pits. The ever-expanding option volumes evolved into the current technology-dominated market making industry. In this article we will discuss how Black-Scholes and the binomial tree calculations that followed it shifted traders from clever people who stood in the pits to technologists who create complex trading and investment algorithms.