In previous articles we have briefly described the specialist trading system traditionally used on the major stock exchanges, the competing dealer system used by the NASDAQ, and the strengths and weaknesses of each. In the pre-1973 era, there was also some trading in securities known as stock options, traded through a loosely associated group of over the counter dealers known as Put and Call brokers. Stock options are either the right to buy a stock at a specified price for a specified period of time, known as a Call option, or the right to sell a stock at a price for a period of time known as a Put. All the transactions using options through the Put and Call dealers were traditional over the counter trades. This means that the dealer would take the other side of the customers trade, and any closing trade had to occur with that same dealer.

In the late 1960's and early 1970's there was a flurry of ground-breaking research being done on security trading and trading history, both in stocks and other products. Particularly intense research was taking place at the University of Chicago, where emphasis was being placed on establishing huge files on trading history and serious quantitative studies on that history. Also being scrutinized, along with anti-competitive studies in other industries such as airlines and trucking, was the theoretical base, if any, of the monopolistic specialist systems used on the major stock exchanges. In addition, the research indicated that there was a theoretical demand for the ability to hedge stock transactions through the use of Put and Call options, and the relative clumsiness of the Put and Call broker system was an impediment to that growth.

On a totally independent path to the academic research was the growing desire of the Chicago Board of Trade to expand their product mix beyond the traditional mix of agriculture futures. The CBOT trading system was totally different from the monopolistic specialist system. It consisted of a huge number of competing members that were free to take positions in the various products, execute orders for customers, or make markets in the products. The system is essentially similar in ease of entry and competitive pricing as the NASDAQ system, but is under one roof. Having the main academic push for the expansion of the option product and an exchange looking for new products in the same city created enough synergy for the CBOT to make application to the SEC for a new options exchange. Under the relentless push of the project manager and friends in academia, the new exchange finally made its way past the entrenched special interests of the New York specialist and brokerage communities and opened in April, 1973.

The new Chicago Board Options Exchange started as a blend of all that was perceived as the best of the other trading systems, specialist, NASDAQ, and CBOT. In addition, a new central clearinghouse, The Options Clearing Corporation, was created to essentially guarantee to all customers the ability to open and close transactions with one contra-party and the integrity of the exercise and assignment process. Other characteristics of the new exchange guaranteed customers the following:

1. Customers would receive the same single price opening that was considered a strength of the traditional exchanges, and a weakness in the NASDAQ system.
      
2. There would be a central order book for customer orders to be placed, making the routine customer trade-throughs, common on the NASDAQ, impossible.
      
3. The central location made it easier to execute larger market orders, as it was easier to police against other dealers pulling their bids and offers, or, worse yet, actually competing against the customer order. These practices had been widely alleged on the NASDAQ system.
       
4. Bid and ask spreads were the result of competing bids and offers by many competing members of the trading crowd, not one specialist, and should therefore be narrower. In fact, this seemed to be borne out in practice.
      
5. There was a statutory separation of principal and agent, meaning that the person executing customer orders could not trade on a proprietary basis in that stock on the same day. All those constant questions about fiduciary responsibilities and inherent conflicts were neutralized.
    
6. The existence of a central clearing house meant that trades could be closed at any time with any market participant, as it now was each market participants position at the clearinghouse that mattered. Simply put, a customer buys a specific contract on Monday, and sells the same contract on Wednesday, he now has no position.