In the story on put options trading in last Sunday's section, the distinction between striking price and premium was made erroneously. The striking price is the price at which a buyer of the option may sell the underlying stock issue at a future date - for instance, $100 a share in three month's time. The premium is the marginal fee paid to the writer of the option or to a brokerage firm for issuing the option - say $5, a share on 100 shares whose striking price is $100 each, or $500.
A new dimension will be added to the dynamic options market this week which promises greater strategic flexibility - and a plumper bag of tricks - for the creative investor.
With the symbolic ringing of bells Friday morning on the Chicago Board Options Exchange, and the American, Philadelphia, Midwest and Pacific Stock Exchanges, the buying and writing of put options on 25 listed stocks will begin.
While puts on some over-the-counter issues have been traded for years, the institutionalization of such trading is eagerly anticipated by the nation's options specialists and many investors. Only four years ago, the CBOE became the first organized marketplace for call options. While the excitement and volume generated by that move is not expected t obe matched by the addition of trading in puts, brokers and investors are enthusiastic nonetheless.
"Puts add more flixibility for investors who want to straddle or put on a spread and for arbitrageurs," said Paul Sweeney, an options specialist in the Washington office of Merrill Lynch, Pierce, Fenner & Smith.
"No one knows for sure what the effects of trading in puts will be, but it could double the options volume again by increasing trading in calls as well," he added.
To understand options trading, an explanation of calls is necessary.
A call option gives the buyer of the option the right to purchase 100 shares of stock at a stated price any time before th expiration date. The stock is referred to as "the underlying issue." The cost of the option is called "the striking price" or premium. Buying a call option is also referred to as "calling away." Options can be purchased with expiration dates of three, six or nine months - a limitation which frustrates seekers of possible long-term capital gains.
An investor can choose to play one of two sides in an option transaction, as either the writer or the buyer.
The buyer is a speculator who anticipates that the value of the underlying issue will rise during the period he holds the call option. Brokers variously described call buyers as "very aggressive," "very speculative" and "unusually bullish, willing to take risks."
The attractions of buying a call option rather than the stock itself are many. It takes only a fraction of the cash. The risk is limited to the size of the generally modest premium. And, for a minor investment, a buyer can make a percentage gain for larger than that made on any rise in the value of the stock.
For example, if an investor chose to take a call option on 100 shares of XYZ stock which are listed at $100 each, he might be required to pay $5 a share for a three-month option, or $500 total. Say the price of the stock rose to $110 a share after he had held the option for two months. If the buyer executed his option at that time, his profit would be $5 a share, or $500, once the amount he paid as the premium were deducted. If the price of the shares during the three months held at $105 or less, the buyer would not execute the option. But his loss would not exceed the $500 premium.
Buyers usually don't execute the option by buying the stock, but by selling the option back to the option writer or to another investor.
Conservative investors with their own portfolios protect their investments by writing options on the stocks they own. The premium, $5 a share in the example, is extra income which multiplies the yield on the portfolio. It also serves as insurance to protect the investor if the value of his stock slides.
The only risk to the writer of a "covered" option - one who owns the underlying stock - is that the value of the shares will rise above $5 and the buyer will call away the shares. While the writer then would see his own gain on his portfolio go to the option buyer, the writer would suffer no dollar loss himself.
A call option writer who doesn't own the underlying shares is also specualting. If a buyer exercises his option on a "naked" call, the writer will have to buy the stock at the current market value in order to sell them to the buyer at the striking price. But if the shares do not rise in value enough to cause the buyer to execute the option, the writer keeps the premium as profit. The writer's only costs are the broker's commission.
And now for puts.
A put option gives the buyer the right to sell 100 shares of stock at a specified price before the expiration date. A buyer of puts is betting that the market will decline during the period of the option and thus is bearish.
For example: An investor buys an option to sell 100 shares of XYZ stock at $100 a share. The striking price is $5 a share, or $500. If the market value of XYZ falls to $90 a share, the investor's profit - less the premium - is $5, or $500. To execute the option, the investor would sell the shares back, or "put to," the writer or any other investor. If the value of the shares rises, holds steady or falls only to $95, the buyer will not execute the option.
While the "hot" options market has won wide attention for the substantial profits - and massive losses - some investors have made in it, options specialists say that such trading is neither inherently speculative nor particularly risky.
In fact, it has attracted some of the nation's most solid, conservative corporations, banks and insurance companies as well as government agencies who have increased yields on their investment portfolios by writing options against stocks they own.
"It depends on how you use them," explained Les Silverstone, who heads Dean Witter's Washington office. "If you buy a call or put option outright, that's speculative but not necessarily risky - that depends on the stock. But if you're hedging a position - either selling a stock short and buying a call option simultaneously, or buying the stock as well as a put option, that's extremely conservative because you're protecting yourself against up or down price movements."
As Merrill Lynch's Sweeney explained, "Think of it as hedging a crop. But in this case the crop being hedged is stock and securities."
Call options can be purchased on 243 listed stocks, with many of the most active options traded on more than one of the five exchanges. Brokers advise their clinets to concentrate their options efforts on issues that are volatile and have frequent price moves, while avoiding the "too speculative" stocks. Sweeney cited IMB, Digital Equipment and Mesa Petroleum as among his favorites.
"For someone writing an option, the stocks that move around a lot get high premiums. Utilities and high-dividend stocks aren't popular because the premiums are low as well as the risk," he said.
Some brokers have criticized the selection of the 25 stocks on which put options can be written for the initial five-month experimental phase. "I'm disappointed, quite frankly," said Ralph Worthington IV, first vice president of Blyth Eastmen Dillon in New York. "They aren't particularly attractive to writers or buyers except for the CBOE's choices of IBM and Eastman Kodak."
The 25 stocks involved and the exchanges on which their options may be traded are:
CBOE: Avon Products, Eastman Kodak, General Motors, Honeywell and IBM.
Amex: Aetna Life & Casualty, ASA, Ltd., Mesa Petroleum, Reserve Oil & Gas and Westinghouse Electric.
Midwest: COrning Glass World, Northwest Industries, Inc., Revlon, Inc., Hughes Tool Co. and Carrier Corp.
Philadelphia: Allis-Chalmers Corp., Amerada Hess Corp., Continental Oil, Inexco Oil and The Pittston Co.
Pacific: American Broadcasting Cos., Inc., Heublein, Levi Strauss, Santa Fe International Corp. and Schering-Plough Corp.
One explanation fo the thin stock selection is offered by Frank Moore of the Securities and Exchange Commission, who processed the put options filing.
"The exchanges were trying to avoid stocks that are daully listed," he said. "Unfortunately, those are the more popular issues."
The competition for the options investors' dollars has escalated into near open warfare between the CBOE and Amex, the first and second leading options markets. While the commissions on options transactions are lower than those on stocks, the rapid turnover in options and frequent manipulation of calls into synthetic puts and other strategies add up to substantial profits for brokers as well as exchange clearing houses.
While the CBOE, which has the top volume on options now, appears to have the edge on the Amex, the latter is transmitting stron gsignals that it is taking the battle seriously. On THursday, the Amex named Robert J. Birnbaum, a 49-year-old options specialist, as its new president with a salary rumored to be $120,000 to $130,000 a year.
Wall Street sources said Birnbaum had been offered the presidency of the CBOE, which triggered the Amex's board offer of their top job in order to keep him in New York.
Also on THursday, the CBOE board of directors told exchange members it would petition the Securities and Exchange COmmission for permission to begin trading in stocks in an apparent move to fend off proposals by the New York Stock Exchange and the National Association of Security Dealers to deal in options.
The SEC has been encouraging competition among the domestic marketplaces, but the acrimonious bidding for investment funds is not exactly what the agency bargained for.
The terse statement issued by the CBOE could not be more clear: "Options are our business. As stock exchanges get into options, we want to remain competitive."
For investors who want ot learn more about options trading, Blyth Eastman Dillon is offering a national "hotline" presentation on June 6 at 4:15 p.m. A presentation by the firm's options specialists and CBOE president Joseph Sullivan can be heard at each of the company's branch offices at that time, followed by a question-and-answer session for investors with Sullivan and Blyth Eastman executives.