BREAKING THE CHAIN OF TRANSMISSION
now for peoples practitioners should face reality. This explains our concern with the “scientific” notion that practice should fit theory. Option hedging, pricing, and trading is neither philosophy nor mathematics. It is a rich craft with traders learning from traders (or traders copying other traders) and tricks developing under evolution pressures, in a bottom-up manner. It is technë, not ëpistemë. Had it been a science it would not have survived – for the empirical and scientific fitness of the pricing and hedging theories offered are, we will see, at best, defective and unscientific (and, at the worst, the hedging methods create more risks than they reduce). Our approach in this paper is to ferret out historical evidence of technë showing how option traders went about their business in the past.
對于我們來說，從業者，理論應該出現從practice2。這就解釋了我們的關注與“科學”的概念，這種做法應符合理論。期權對沖，定價和交易既不是哲學也不是數學。這是一個豐富的工藝與貿易商貿易商（或復制其他貿易商的貿易商）和技巧發展進化壓力下學習，在一個自底向上的方式。這是技藝，而不是認識論。如果這是一門科學，就無法生存 - 定價和套期保值理論提供的是經驗和科學的健身，我們將會看到，在最好的情況下，有缺陷的和不科學的（在最壞的情況下，對沖的方法創造更多的風險比他們減少）。在本文中我們的做法是深挖歷史證據顯示期權交易如何去對他們的業務在過去的技藝。

Options, we will show, have been extremely active in the pre-modern finance world. Tricks and heuristicallyderived methodologies in option trading and risk management of derivatives books have been developed over the past century, and used quite effectively by operators. In parallel, many derivations were producedby mathematical researchers. The economics literature,however, did not recognize these contributions, substituting the rediscoveries or subsequent reformulations done by (some) economists. There is evidence of an attribution problem with Black-Scholes- Merton option “formula”, which was developed, used, and adapted in a robust way by a long tradition of researchers and used heuristically by option book runners. Furthermore, in a case of scientific puzzle, the exact formula called “Black-Sholes-Merton” was written down (and used) by Edward Thorp which, paradoxically, while being robust and realistic, has been considered unrigorous. This raises the following: 1) The Black-Scholes-Merton was just a neoclassical finance argument, no more than a thought experiment3, 2) We are not aware of traders using their argument or their version of the formula.
我們將展示前現代金融世界中，一直非常活躍。在過去一個世紀中，期權交易和風險管理的衍生工具書的訣竅方法在已開發相當有效地使用運營商。與此同時，許多派生producedby數學研究。然而，經濟學文獻中，沒有承認這些貢獻，代做一些經濟學家重新發現或后續的重新配方。有證據的歸屬問題與布萊克 - 斯科爾斯 - 默頓“公式”選項，開發，使用和適應的研究有著悠久的傳統，在穩健的方式，并試探性地使用期權賬簿管理人。此外，在科學之謎的情況下，確切的公式被稱為“布萊克 - 肖爾斯 - 默頓”寫下來（用）由愛德華·索普，矛盾的是，穩健和現實的.

First, something seems to have been lost in translation: Black and Scholes (1973) and Merton (1973) actually never came up with a new option formula, but only an theoretical economic argument built on a new way of “deriving”, rather re-deriving, an already existing –and well known –formula. The argument, we will see, is extremely fragile to assumptions. The foundations of option hedging and pricing were already far more firmly laid down before them. The Black-Scholes-Merton argument, simply, is that an option can be hedged using a certain methodology called “dynamic hedging” and then turned into a risk-free instrument, as the portfolio would no longer be stochastic. Indeed what Black, Scholes and Merton did was “marketing”, finding a way to make a well-known formula palatable to the economics establishment of the time, little else, and in fact distorting its essence.

There are central elements of the real world that can escape them –academic research without feedback from practice (in a practical and applied field) can cause the diversions we witness between laboratory and ecological frameworks. This explains why some many finance academics have had the tendency to make smooth returns, then blow up using their own theories6. We started the other way around, first by years of option trading doing million of hedges and thousands of option trades. This in combination with investigating the forgotten and ignored ancient knowledge in option pricing and trading we will explain some common myths about option pricing and hedging.

Options have a much richer history than shown in the conventional literature. Forward contracts seems to date all the way back to Mesopotamian clay tablets dating all the way back to 1750 B.C. Gelderblom and Jonker (2003) show that Amsterdam grain dealers had used options and forwards already in 1550.

In the late 1800 and the early 1900 there were active option markets in London and New York as well as in Paris and several other European exchanges. Markets it seems, were active and extremely sophisticated option markets in 1870. Kairys and Valerio (1997) discuss the market for equity options in USA in the 1870s, indirectly showing that traders were sophisticated enough to price for tail events8.

One informative extant source, Nelson (1904), speaks volumes: An option trader and arbitrageur, S.A. Nelson published a book “The A B C of Options and Arbitrage” based on his observations around the turn of the twentieth century. According to Nelson (1904) up to 500 messages per hour and typically 2000 to 3000 messages per day were sent between the London and the New York market through the cable companies. Each message was transmitted over the wire system in less than a minute. In a heuristic method that was repeated in Dynamic Hedging by one of the authors (Taleb,1997), Nelson, describe in a theory-free way many rigorously clinical aspects of his arbitrage business: the cost of shipping shares, the cost of insuring shares, interest expenses, the possibilities to switch shares directly between someone being long securities in New York and short in London and in this way saving shipping and insurance costs, as well as many more tricks etc.

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It is clear that option traders are not necessarily interested in probability distribution at expiration time – given that this is abstract, even metaphysical for them. In addition to the put-call parity constrains that according to evidence was fully developed already in 1904, we can hedge away inventory risk in options with other options. One very important implication of this method is that if you hedge options with options then option pricing will be largely demand and supply based15. This in strong contrast to the Black-Scholes- Merton (1973) theory that based on the idealized world of geometric Brownian motion with continuous-time delta hedging then demand and supply for options simply should not affect the price of options. If someone wants to buy more options the market makers can simply manufacture them by dynamic delta hedging that will be a perfect substitute for the option itself. This raises a critical point: option traders do not “estimate” the odds of rare events by pricing out-ofthe- money options. They just respond to supply and demand. The notion of “implied probability distribution” is merely a Dutch-book compatibility type of proposition.