THE CHICAGO BOARD OPTIONS EXCHANGE is the latest investment opportunity to challenge for the title of legitimate Bird Nest On the Ground for investors. Brokers are cheering for the CBOE to make it since the current score is Bird Nests 37, Investors 0.
The CBOE aims to bring trading in options on stock out of the closet and into the light of a central marketplace, and in so doing LaSalle Street has stolen a march on Wall Street. The Chicago Board of Trade fathered the Options Exchange, and that parenthood left the financial community in New York looking slightly impotent. Belatedly, the American Stock Exchange is studying a pilot program of trading options on the Curb, which these days greatly resembles a harvested rice field, much in need of replanting.
Of course, New York is not entirely defenseless in any battle with Chicago. The Wall Street Journal, for instance, carries page after page of stock tables each business day. There are stock tables from the Big Board, the Curb, the Pacific Coast, Toronto, Montreal, all commodity exchanges, and many others. The table on the CBOE transactions, however, appears on the inside back page of the Journal and is clearly labeled an “Advertisement.” Chicago may have stolen the girl, but New York gets the alimony.
No investor can understand the opportunities on the CBOE without first having a rudimentary understanding of options, which are essentially the right to buy or sell a particular stock at a specific price anytime during a defined time. One minute after their expiration time, options aren’t worth the paper they’re written on, but during their brief life they can be as exciting or as disappointing as the Houston Astros, who, it is rumored, are moving to the Philippines to become the Manila Folders.
To own 100 shares of American Telephone and Telegraph, an investor must come up with some $5000 plus commissions, but to control 100 shares of the same stock for a few months through an option on the CBOE costs only a couple of hundred dollars.
While your option is alive, if Telephone went to $60 a share, you could buy the stock at 50, sell it at 60 and keep the difference less commissions and the cost of the option.
Your maximum risk is the total amount you paid for the option. If American Telephone and Telegraph goes bust, the most you can lose is your investment in the option. Limiting the risk is one of the main advantages of options.
“Wouldn’t it have been better to own a call on Levitz Furniture at 60 than to have owned the stock and not sold it?”
A pithy argument, indeed.
Options have been around for a long time, but they have been trading over the counter on a negotiated basis. Apparently, it has been a seller’s game since only about one-fourth of all the options purchased were ever exercised. Three out of four were allowed to die a quiet death with a total loss of the investment to the buyer. Each option needed two parties: the taker and the takee.
Several brokerage firms maintained formal options departments and made an effort to match buyers and sellers within their own systems. But if an investor wanted to buy an option on a particular stock and there were no offers around, the broker had to contact one of the few houses that specialized in trading options. The option house often would have one of its customers write the option. The premium was negotiated, many times to the advantage of the writer and corresponding disadvantage to the buyer. Buyers wanted options on the most volatile stocks in hopes of great rewards, and writers obliged them but made the cost dear.
And then along came the CBOE in 1973 to put the buyers and sellers of options together in one auction market. The CBOE incorporates some of the features of commodities trading. For instance, if you’ve written an option on Exxon that expires in January and the stock and option prices decline, you can buy that particular option back. It’s like being short a contract of soybeans without the risk.
The ready marketplace for options helps the buyer, as well. If he buys an option that gets “in the money,” all he bas to do to reap his profit is sell the appreciated option. “In the money” options over the counter are normally cashed by calling the stock away from the seller and selling it the same day. Selling the option itself involves a commission based on its price, not the price of the underlying stock. The minimum commission charge for sale of a CBOE option is $25 as compared to the $65 it would cost to sell 100 shares of Exxon, for instance.
Another feature of the CBOE is the generally good quality of the stocks on which options are offered. The list is growing rapidly, but the quality remains pretty high. There are options on such blue chips and glamours as Exxon, Telephone, Eastman Kodak, and Xerox. Expiration dates on CBOE options are uniform. Every October option expires the last business day of October, no matter when you buy it. All striking prices on that option are the same, too. All the Exxon options currently trading are based on a price of $100 per share, which means the option holder can claim the stock backing up the call at $100 per share anytime during the period the option is alive.
Investors sometimes get “locked in” a stock that declines a large percentage, but the CBOE has found away to avoid that trap. If a stock declines too much below its striking price, the CBOE simply introduces another class of options in that same stock at a lower price. Recently ten of the 26 issues listed on the CBOE sported options trading at more than one striking price. Brunswick options were trading at three different striking prices.
CBOE options differ from over the counter options in one other important respect. The CBOE ignores dividends. If you own 100 Exxon and write an OTC option against it, the striking price must be reduced by the amount of each dividend. Not so on the CBOE. Writing a six-months option on Exxon on the CBOE allows you to keep $2.20 per share in dividends without a corresponding reduction in the striking price. Score one in favor of the writers of options at the expense of the buyers.
Like any investment idea struggling for the elusive title of Bird Nest On the Ground, the CBOE must have a little time to prove itself. On the basis of the first set of options on the exchange—the July, 1973’s—there weren’t any big winners. When those contracts expired, many stocks were considerably below their striking prices. Buyers of options lost most of their investment if they stayed too long at the Fair. Writers pocketed the premiums, which may not have completely cushioned the decline of the stocks they wrote against.
But perhaps the July, 73’s, shouldn’t be used to judge the CBOE against the BNOG standard. After all, the stock market was about as interesting as the submarine races during that period.
“It’s got to get better,” he said, hopefully.
Volume on the CBOE is knocking around 5000 options per day, and open interest—the number of options outstanding—has been more than 60,000 and increasing as new stock options are added.
Some critics have compared the CBOE to the old bucket shops of Jesse Livermore’s era where investors could place what amounted to a bet on the immediate decline or advance of a particular stock. That’s unfair. The CBOE may indeed fill a need for both buyers and sellers of options by putting them together in a visible marketplace. At least, there will be greater liquidity in the trading of options. The CBOE certainly fills a need for stockbrokers, who need to do some kind of business, regardless.
But is the CBOE a BNOG? An experienced stockbroker answered the question:
“Of course. It’s going to be a lot better for investors to trade CBOE options than to trade listed securities. After all, with CBOE option all you have to do is figure out whether the stock is going to go up or down!”