Some stock brokers are advising small investors to be wary of Wall Street today because big traders will be making some multimillion-dollar buying and selling decisions that could cause stock prices to gyrate wildly.
The predictions of potentially erratic stock prices have little to do with the stock market boom that drove the Dow Jones industrial average up 400 points in the last four months and sent it over the 1,800 mark yesterday.
The threat comes from computer-driven trading programs that tell big professional investors to buy or sell stocks or other investments in hundreds of companies at once in coordination with massive trades in the futures and options markets.
Computer trading programs have made the stock prices more volatile, but the situation isn't bad enough to require any sweeping changes in market rules, according to a study released yesterday. The study was paid for by the five options exchanges.
Today, the risk of stock prices jumping up or down is particularly great because of what Wall Street calls the "triple witching hour" that will occur between 3 and 4 p.m. today.
That is the final hour of trading for March stock-index futures contracts, stock-index options and individual stock options. Options and futures give investors the right to buy or sell stocks at a fixed price at any time until the contacts expire.
As today unrolls, high-speed computers will track and compare the prices of hundreds of stocks and futures contracts minute by minute, with traders watching for an opportunity to sell their stocks early and close out their interests in the futures contracts. They must act by 4 p.m. to reap their profits. That deadline can bring orders to sell millions of shares of stock to the stock-exchange floor simultaneously, causing share prices to plunge as they have done on several previous "triple witching hours," which occur on only four Fridays a year.
Wall Street experts are advising individual investors to buy or sell stocks before the "triple witching hour" so they are not hurt by sharp stock price swings that can be caused by computer-directed trading programs.
Many market professionals who play the options and futures already have settled their contracts, leading executives at such Wall Street firms as First Boston Corp., Drexel Burnham Lambert Inc. and Prudential-Bache Securities to say they do not expect major stock-price volatility this afternoon.
However, because stock prices have been volatile on some previous triple-witching Fridays, Wall Street experts suggest caution.
"The only strategy I would advise is, if I had anything to do, I would finish it before 3:30 p.m. on Friday and not be subject to any possible vicissitudes," said Drexel's Howard Brenner. "It is possible that there will be some distortions. Why be involved in a distortion if you don't have to?"
Larry Wachtel of Prudential-Bache Securities agreed.
"Speculators should be aware of it, traders should be aware of it and the average man in the street should shun this [triple-witching hour] completely," Wachtel said. "There is no investment character to the final hour. This is simply a mechanical venture in which the Dow could rise 20 or 40 or fall 20 or 40. It has nothing to do with earnings and stock dividends. The average investor unable to fathom the magnitude should avoid it."
Primary concern about volatility this afternoon is focused on the stock-index futures. The index-futures contract allows investors to speculate on the overall direction of the stock market. For example, by buying a March futures contract on the Standard & Poor's 500 index, an investor was guessing where the S&P 500 index will close today.
The computer-directed trading trick used by most market professionals involves betting on the S&P 500 stock-index futures and, at the same time, buying shares in most or all of the 500 individual stocks that make up the S&P index.
For example, a computer program may have told a trader several weeks ago that the combined value of the stocks in the S&P 500 was slightly less than the price at which S&P 500 futures contracts were trading. By buying a huge basket of the stocks -- at least $20 million worth, experts say -- and simultaneously selling a corresponding amount of futures contracts to deliver the stocks at a higher price, the trader could guarantee a profit.
How much profit depends on when the stocks and futures investments are cashed in. That can happen at any time before the contracts expire, but the last opportunity will be this afternoon. Because the stock market has been moving up steadily for weeks, most stock-index program traders already have had a chance to take their profits and reinvest their money, Wall Street specialists say.
New York Stock Exchange Senior Vice President Donald Solodar compared the index-futures trading strategy to making money by buying a fruit salad and selling individual pieces of fruit.
"You can buy individual pieces of fruit, an apple, a banana or a pear [individual stocks], or a fruit salad [index futures], which has all three of them in it," Solodar said. "If the fruit salad sells for $1 and individual pieces of fruit that make up the fruit salad sell for a total of $1.10, what you could do is buy the fruit salad and then sell the individual pieces of fruit . . . and lock in that 10-cent difference."
The new study of what happens to the stock market on triple expiration days was conducted by Hans R. Stoll, a professor at Vanderbilt University. Stoll concluded that stock prices become much more volatile on triple expiration days than on other days and raise the level of trading.
Stoll ruled out a number of possible changes in market rules, including a proposal that would require traders to reduce the number of options or futures contracts they can hold as expiration day approaches.
" . . . At this time, the evidence on the magnitude and frequency of expiration-day price effects is not sufficiently compelling to warrant changes in expiration-day procedures," Stoll wrote.
He noted that "the expiration-day phenomenon has the advantage of occurring at a predictable time, which gives investors the option of staying away."
Strategies that could affect the stock market today involve stock-index options and individual stock options. Index options give investors the right to to buy or sell a quoted value of the index for a set price during a specified period. Stock options give investors the right to buy or sell shares of a particular company at a set price during a specified period.
The potential last-minute mania should be minimized today because most firms have agreed to notify the stock exchange in advance if they plan to unload giant baskets of stocks at the close of trading. This notice enables the specialists who manage the trading of individual stocks on the floor of the New York Stock Exchange to arrange trades in advance, which helps to create an orderly market and stable prices.
While the focus on options and index futures may sound more like Las Vegas than Wall Street to many investors, stock market professionals who correctly use the strategy of selling the index futures and buying stocks actually reduce their risk of investing in stocks. They do so by locking in profits through a trading strategy that was impossible before the index futures were created a few years ago and before computers were harnessed to keep track of all the stock, options, index and futures prices at once.
Any sharp stock price swings caused by computer-driven trading today should be short-term in nature, Prudential's Wachtel said. Computer trading with stocks and stock-index futures merely accelerates the prevailing market trend, he said, adding that individual stock prices should correct themselves within days.
The past two triple-witching Fridays have had less volatility than previous triple-witches, a possible sign that new trading strategies have emerged that have reduced the price swings.
On Dec. 20, the Dow Jones industrial average closed down 0.92 point, while the Dow closed down 8.85 points on Sept. 20. The Dow was up 24.75 points on the previous triple-witching Friday, June 21, while the Dow moved down 12.70 points a year ago on March 15, 1985. Three of the four Fridays in 1984 were down days, with drops of 10.71, 14.80 and 4.31 points. Two years ago on March 16, the Dow moved up 16.96 points.
Richard Chase, associate director of market regulation at the Securities and Exchange Commission, said the trend shows that volatility has been decreasing. "Until the last couple of quarterly expirations, which have been fairly quiet, there had been volatility," Chase said.
Chase said the SEC continues to monitor the situation closely.