Commodity option pricing efficiency before Black, Scholes, and Merton

It is often thought that the arrival of the Black–Scholes–Merton (BSM) model of option pricing in the early 1970s allowed traders to understand how to price and value options with greater precision. However, our study suggests that interwar commodity options traders may have been able to intuit ‘fair’ value and to adjust their prices to changes in the market environment well before the advent of this innovative model. A scarcity of historical price data has limited empirical tests of option price efficiency well before BSM to studies of stock options in the 1870s and the early twentieth century which revealed contrasting findings. This study deals with option pricing in a different market—commodities—during the interwar period. We conclude that option prices were closer to their BSM theoretical values than prior studies suggest. Institutional differences between interwar commodity options markets and stock options markets in the 1870s and the early twentieth century may partly account for this result. Furthermore, we find that interwar option prices were no more mispriced than in modern times, and were as sensitive to changes in volatility—the key valuation parameter in the BSM model.