Stock-market purists aren't buying stocks anymore. Instead, they're wagering on whether the stock-market averages will rise or fall.
The heaviest betting centers on Standard & Poor's 500-stock average and the New York Stock Exchange Composite, both of which measure the market action in leading companies. Stockbrokers book your bets, which can be placed for as short a time as a few hours or as long as a year and a half.
The action is faster than it is with individual stocks, and the winnings bigger--if you win. Losses can turn pockets inside out in a matter of days. "I don't need these games," said one discouraged investor. "You might as well play the numbers." But volume is soaring on these new exchanges, as players test their pride against the moving market averages.
There are two ways to bet: (1) On stock-market futures, which is a direct bet on the market trend; or (2) options on stock-market futures, which is a gamble on which way the futures are going to move. You could describe either investment as a piece of paper betting on the changing worth of another piece of paper. The futures are generally considered riskier than the options, but neither one is a place for money that you can't afford to lose.
When you speculate in futures, you are gambling that the stock market, as measured by specific market averages, will rise or fall within a certain period of time. Given a rising market trend, as we have today, such an investment sounds simple. Who would argue that stocks will probably be higher over the next year than they are now? You simply put up $6,000 (for an S&P contract), sit back and wait for your reward. A small move in the stock market will produce a large gain in your futures contract. When you sell at a profit you get back your original $6,000 stake plus all the proceeds of the sale. Your only cost is the broker's commission.
The risk is that you might guess right about the general market trend but wrong about what is going to happen in the next week. If the market falls a few points, and the value of your $6,000 contract drops below $4,500, your broker will ask you to put up more money. If you don't, you'll be sold out at a loss.
Even in a rising market, a sharp two-day reversal could generate a call for additional funds, and then what would you do? An investor with strong faith in the market trend (and extra cash on hand) might put up the additional money. A nervous investor might let himself be sold out. Only time would tell which course was right.
A futures investor depends strongly on his stockbroker to keep him informed. If you're caught in a rapidly falling market, and the broker doesn't call right away, you might not be able to sell out before your loss exceeds your original $6,000 stake.
With options, on the other hand, your losses cannot exceed your original stake, which makes options more appealing to many investors.
An option on an S&P futures contract might cost $2,500 to $3,000. If the market runs against you, you can lose no more than the money you originally put up--which makes it safer, on a small investment, to sit tight and see if the market will swing back to the winning side. (When you sit tight on a futures contract, by contrast, there is no limit to your losses if the market does not revive.) Another nice thing about option investments is that your broker will not ask you for extra funds to maintain your position.
In return for limited losses you get smaller profits than you would in futures. "If a futures contract goes up by $1, its option will rise by an average of 50 cents," says Barry Frost-White, director of options and indexes at ContiCommodity Services.
When you buy a call option you are betting that the market will rise. When you buy a put option you are betting that the market will fall. For you to make money, the market has to rise (or fall) enough to cover the price you paid for the option, plus broker's commissions.
If you buy a call option that expires next June, you could sell any time between now and then--which appears to offer a good chance for profit in the rising stock market generally expected in a presidential election year. But markets can surprise you, and both options and futures give you only a short time for your expectations to work out. If you haven't made money by the closing date on your investment contract, it will expire worthless. Long-term investors are better off in mutual funds or stocks.