ercentage of Options Exercised
Consider as you learn option trading here that I can
remember when I testified before the Senate Finance Committee in 1934.
I will address specific aspects of option trading in history later in
this chapter but in this space grant that I was, of course, younger and
less experienced at that time. I am explaining, ultimately, that options
are effective as insurance, but I digress... I had been in the option
business for fifteen years at that time and, although the business then
was different from what it is now, I knew it well. I had already appeared
before Congressman Sam Rayburn's committee in the House and now I had
been selected by the Put and Call Brokers and Dealers Association to represent
the industry before the Senate. There I was in a big room with a "mike"
before me; the senators who were on the committee sat at a large table,
and there were about three hundred spectators and witnesses in the room.
I was facing Senator Fletcher, Ferdinand Pecora, Ben Cohen, and "Tom"
Corcoran—the framers of the Securities Act. "Tom the Cork,"
as Mr. Corcoran was called, had explained the bill, paragraph by paragraph,
and when he came to the part dealing with options, he said, in substance,
"Not knowing the difference between good options and bad options,
for the matter of convenience we strike them all out." Don't hold
me to the exact words, but that was the essence of it and it was my job
to show the difference. I think I did a good job. As I have said, the
business of options was turned over to the newly formed SEC and, sitting
before this body, I explained the difference between "the options
in which we deal which are publicly offered and openly sold for a consideration,
and the manipulative options that had been secretly given, for no fee
but for manipulative purposes."
To get back to the reason for the heading of this section concerning your
effort to learn option trading from history, Mr. Pecora, after other questions,
asked me the percentage of options that were exercised, and I told him
that about 12½ per cent were exercised at or before expiration.
Remember that in those days options were mostly of 30-day duration written
not "at the market" price, but away from the market. In those
days we also negotiated options for 2 days, 7 days, and 15 days. (More
about this later.) But stock prices were high in the twenties (as we later
found out), and with General Motors over $300, U.S. Steel over $325, and
many stock in the hundreds, it was quite common to trade options 20, 30,
or even 40 points away from the market for 30 days.
Mr. Pecora then asked something like this: "If only 12½ per cent are exercised, then the other 87% per cent of the people who bought options have thrown their money away?" "No, sir," I said, "if you insured your house against fire and it didn't burn down you would not say that you had thrown away your insurance premium."
The same thing is true about options. Today the 30-day option is a very small percentage of our business, and the longer contracts in which we now deal constitute a very much greater percentage of options exercised. However, whether an option is exercised at expiration or not, it does supply considerable protection and advantage to the holder during its life.
Just one short example: A man owns stock that cost him 40 and is now selling at 70. He protects that profit with a 90-day Put at 70, for which he pays $400. During the life of the option, the stock advances to 80, and Mr. Trader allows his Put option to lapse. Instead of his selling his stock at 70, the protection afforded by the Put provides him with the incentive or courage to hold the stock for an additional 10 points profit without risking the profit he already has. The option isn't exercised, but would you say that Mr. Trader "threw away" the premium that he paid for the Put option, or did he have protection during the life of his option for his full profit and against an unlimited loss?
As I believed would help you learn option trading, it will now be interesting
to the reader at this point, after reading so much of the techniques of
the option business, to know something of "years ago." When
I first came into the option business forty years ago, and up until about
the time of the "big break" in 1929, the holder of an option
could trade against it with no margin. His broker had to have coverage
for just the commissions and interest and any market difference. Often
I had Puts on 500 shares against which I would trade, back and forth,
as many times as the swings in the market would allow; margin was not
necessary because the option, guaranteed by a member firm of the New York
Stock Exchange, was sufficient margin. Not so today, however. Today all
stock commitments must be covered by the required margin and the option
is not a substitute for such margin.
"Years ago," Spreads and Straddles were sold so that the exercise
of one side of the option, before expiration, voided the other side of
the contract. The Straddle was made out as one contract and the contract
was surrendered to exercise one side. As you learn option trading from
this, you will realise that market volatility has increased now that this
is no longer the case.
"Years ago," there were no tax stamps required on either the Put or the Call option.
"Years ago," contracts were made out in 500 or 1,000 shares, or even in 5,000-share pieces, instead of in single 100-share pieces as they are today. The largest trades I ever made were some 25,000-share pieces, but 5,000-share trades were common. The largest trade I remember was an order I had for Call options on 5,000 shares each on 22 different stocks. The order was filled without too much trouble in about 3 days.
"Years ago," very few option-dealers had their own offices. The "market" was in a restaurant in New Street, New York City, where most of the option-dealers congregated, and many large writers and buyers of options would come to meet with their special option-dealers and give an order. There were telephone booths and a ticker in the restaurant, and the telephone booths were our offices. All the dealers walked around with a pocketful of nickels, ready to use a phone to call a customer and try to make a trade. (A phone call was still a nickel in those days). Of course, we all ate in that restaurant—we had to, for a customer might call and this was our "office."
"Years ago," we did a very large business in "2-day options." We bought them for $25 or $30 per hundred and sold them for $35 or $37.50. They ran from, say, Monday— that would be at any time Monday that we traded—until Wednesday at 2:45 P.M.—the Exchange closed at 3:00 P.M. in those days. We would buy Calls on some stock 2, 3, 5, 10, or 20 points above the market for 2 days. But the number of points demanded for a Call was in proportion to the way the stocks were moving. And if you knew which pool was going to move which stock in the next 2 days, you could do well. There was a broker in the business who would sell a Call on 100 shares of stock good, for the next day only, for one dollar's worth of cigars (which were seven for a dollar, then). The idea was to buy one of those "seven-cigar Calls" and about noon the next day, if the stock had had a run, to sell it for $25 or more—just for the rest of the day. I saw one of my colleagues make $1,200 on a call like that.
Considering how to build stamina as you learn option trading, realise
that all of the brokers would congregate in the restaurant after the close
of the market to "chew the rag." There was one fellow who would
sell lists—100-share Calls on, say, seven different stocks at a
price above the close with the Calls good for the next day—and he
might offer the whole list for $25 or $50, according to the list of stocks.
Very often, before noon the next day, the buyer of the list sold one of
the Calls for $100. Fluctuations were wide in those days and stocks weren't
split so quickly. Some of the leading stocks sold over $300—General
Motors, Mexican Petroleum, Texas Company moved 10-20-30 points in a day.
I remember selling a man Puts on General Motors and Mexican Petroleum
30 points below the market for 30 days. Those Puts cost $137.50 per hundred
shares, but the next day or so those stocks were down 40 points and the
next day they were up 30.1 sold a fellow a Call on Radio once for 30 days
at 100-the stock was 89 and the Call cost $137.50. There were 100 points
in the Call when it was exercised.
"Years ago," there were two individuals in the street—
not Put and Call brokers exactly—who traded for their own account.
They bought Spreads—they would buy a Spread on 500 Studebaker selling
at 80-Puts at 72, and Calls at 90, for 30 days for $200 per 100-share
Spread. If the stock went up in a few days, they sold the Call for $200,
and then if the stock declined they sold the Put for $100 or $200, according
to the price of the stock. But one partner wouldn't sell a contract unless
the other partner agreed, and it was funny to watch one partner run up
and down New Street looking for the other to O.K. a contemplated sale
of a contract. Sometimes a broker would ask to have the contract "in
hand" for a few minutes to see if he could sell it. He'd disappear
into a nearby brokerage office and wait to see if the stock moved and
then come out to say, "O.K., I sold it." As you learn option
trading from this you may realise that while tensions were higher in the
stock market, flexibility was greater.
"Years ago," I remember trading a Call on 10,000 shares of Pan American Pete at 11:00 P.M. at night. When I first started, I did the trading, I made out the contracts in ink—who owned a typewriter?—I made out the checks, I delivered the contract, I picked up the checks and made the deposits, I opened the shop and closed the shop; I was the business. But all of the option-dealers did very well. After a while I chipped in with another broker and we hired a boy for $15 a week to stand at some phone booths in a nearby building (these phone booths were our branch office), and if we were wanted on the phones down the street our boy would come running after one of us "big shots" and whoever was wanted would run up to answer "his" phone. What fun if the restaurant phone wanted you at the same time!
But we had a peculiar sense of honor in those days. If I was sick for a time, one of my competitors would answer my calls and do business for me, and upon my return to work, he would give me a list of the trades he had made for me, along with a check for my profits. And though every one of us was a competitor and would try to offer an option better than the next fellow, the broker who took care of the sick fellow's customers would not, on the latter's recovery, solicit business from his fellow broker's customers. It just wasn't cricket. I had pneumonia once after I had been in business about four years. At the time I was trying to follow a buying pool—only I didn't know that it was selling in another place. I lost my money and worried about my wife and kid, and got sick and contracted pneumonia. I was home for about four weeks, but one of my competitors took care of my business and wouldn't take more than a "thank you" for it.
While I still had my office in my hat—I mean the restaurant—I made a trade in 500 shares with an English fellow I had seen around "the shop," and as he said, "I'll take it," he winked his eye. Trying to be careful because I couldn't afford to make a mistake, I asked him again if it was a trade and again he said, "I'll take it," but gave another wink. I went over to one of the boys and asked him about this fellow, who, every time he said, "I'll take it," winked at me. They reassured me that the sale was O.K.—he just had a nervous twitch—but I was scared.
Despite the length of time I've been in this business, I can remember almost all of the mistakes that were made in trading, they were that few. It's amazing because of the millions of shares of options that are traded: a Put is a Put and not a Call; 100 is 100 and not 500; and Steel is Steel and not Studebaker. I hope I don't jinx it, but I can't remember a serious mistake in our office in almost 10 years.
Just to show how mistakes were not made—often we would call a certain
seller of options at his home at 7 P.M. (he was a fellow who had quite
a thirst—so much so, that his tongue thickened) and we'd trade a
thousand or two with him, and next morning our contracts would come in
100 per cent perfect—just as they had been traded. I don't think
there is another business in the whole wide world that has had as few
errors in the last forty years as the option business. And it's fast—we've
over 50 phones on our trading table, and on a fast day the twelve ears
and twelve hands that our six traders have can't stop for a minute; still,
I think it should get an "Oscar" for being the least understood
of all Wall Street businesses. You might learn from this as you learn
option trading that its hard to feel you've made a good trade in any era
if you aren't rewarded properly.
And speaking of "years ago," the following pages are reproductions of a few pages of a book that was given to me. The book fascinated me so much that I had a limited number of copies made, not only because it tells of the option business and the stock-exchange of those days, but because I felt it was a museum piece. The frontispiece is dated 1875. One of the sketches shows the Sub-Treasury Building at Wall and Broad Streets, New York, but there was no statue of George Washington in the picture, as there is now. I investigated and found out why: George was put there eight years after this little book was published. I have added these few pages of this little book to mine because I thought that the reader would be interested in it. I hold the original in my Wall Street "Put and Call
Library" for posterity.
General Answers to Enquiries
As you learn option trading you might be interested to know,
we have daily inquiries from correspondents at a distance, saying that
living so far from the city, and not knowing the best stock to select,
or the most favorable time to close their contracts, that if we would
attend to not only securing the privilege, but the selection of the stock,
and closing the same, using our best judgment, they would be willing to
forward their money to us for investment. We reply, that when requested,
we will not only secure the privilege, but make the selection of stock
and the kind of contract best to be taken, and also attend to the closing
of same, exercising our best judgment. We are enabled to do this without
prejudice to our customers, as our business is done strictly on commission,
and we are entirely disinterested when we give our views of the market,
which we never do until after studying the movements of the different
cliques, and watching the outside influences that may be brought to tear
on the market. It is to our interest as well as our customers', to select
such stocks as are most likely to pay the best profits, for as we make
money for them, we make it for ourselves, by increasing our business;
and all who trust us with their business may rest assured that we will
attend promptly and faithfully to their interest.
We do not guarantee or promise success in every instance. We present such facts before our readers from week to week as may come into our possession, and give them our best judgment as to the probable course of the market for the ensuing thirty days, and we say to them, if you choose to risk $106.25, you may realize a considerable profit. The stock broker who buys and sells for his customers can do no more than this. If he is consulted and is candid, he will tell his client what he thinks as to the prospects of a stock, desiring him at the same time to exercise his own judgment. He does not guarantee profits or promise success by any means. Those of our patrons who have followed the course of our suggestions, will agree with us when we state that our prognostications have generally proved correct, and when they have taken our advice, success has resulted in nine cases out of ten.
We have no intention of urging people to speculate against their wishes, and we desire to be understood as saying, that any person who has money which cannot be spared, had better not risk it either in speculations on margins or with privileges. If any one feels that he would be distressed by the loss of the funds which he proposes to use in speculation, let him give Wall Street a wide berth. On the other hand, a judicious investment of a few hundred dollars in stock privileges, may be the stepping stone to fortune, and it must be remembered that one profitable venture will repay the losses on a great number of unprofitable ones. So the ball of speculation once in motion is easily kept rolling, and gains at every turn.
All orders by mail or telegraph will receive our prompt attention, and should be addressed,
TUMBRIDGE & CO.,
BANKERS AND BROKERS, 2 "Wall St., N.Y.
- Ff you are undecided which way a stock is going, always take a " Spread;" it costs $212.50, and pays a profit if the stock goes up or down.
- To take an interest in several different stocks will generally be successful; in the numerous fluctuations, which occur everyday, you are certain to make a handsome profit on some of them.
- Where a stock has once been in price, you may look for it to sell there again at some time.
- Short Of Stocks. —To be "Short (f Stocks," or a "Bear," means that you have sold for a decline, stocks, which you have not in your possession, but your Broker borrows for delivery.
- Long Of Stocks. —The expression being " Long of Stocks," or a "Bull," means that you have bought for a rise, and that the shares are in possession of your broker.
- Our long experience in stock operations gives us many advantages, and coming in contact with the great stock manipulators, we are often able to judge of the future market and give our customers very valuable information and advice, enabling them to act upon it.
- We are always careful to make contracts on parties of undoubted responsibility, and our customers can always obtain the name of the party from whom we have bought or sold contracts or stocks for their account.
- The best stocks to secure contracts on are those in which the greatest activity is anticipated. When requested, we will make the investment in such stocks as, in our judgment, will give the largest returns, and will act for parties in securing the profits.
- Contracts Left "With Us we will operate against either by buying or selling, in order to secure the various fluctuations of the day. Our customers are entitled to our services in the selection of the style of investment most likely to prove profitable for their account without extra commission charges.
- If you think stocks are going down secure a Put; or you can obtain a Call and sell the stocks short against it.
- If you think stocks are going up, secure a Call, or you can obtain a Put, and buy the stock against it.
- When a telegraphic order is received by us and we have no funds to the credit oi the person sending such order, a check on New York, payable to our order, must be received by us by first mail.
- We can always make returns the same day a contract is closed.
- Extensions or renewals must be secured before the expiration of the original contract.
- No Liability.—There is no liability, or risk, beyond the amount paid for a privilege.
- Register all mone letters, send large amounts by express or draft on New York, and address all communications
TUMBRIDGE & CO.,
BANKERS AND BROKERS, 2 "Wall St., N. Y.
How $ 2,181.25 Was Made From A Call Costing $106.25
TUMBRIDGE & CO., BANKERS AND BROKERS, 2 "Wall St., N. Y.
demand the stock. If on the other hand the stock should decline, and not advance above the price named in the Call, the only loss that can possibly occur is the amount that may have been paid for the contract.
An actual transaction illustrated will assist the reader. By referring to our books we find that in March, when Union Pacific was selling at 41, we secured calls on this stock at 43 for 30 days, the cost of which was $106.25. The following is a copy of the contract secured :
Every one per cent. Union Pacific advances above the price named, viz.: 43 is equal to $100 on each hundred shares, so an advance of five per cent., the contract would be worth Five Hundred Dollars, an advance of ten per cent, would be a thousand dollars, and so on. This is always the case. One per cent, on a stock that is worth in the market only 15, amounts to just as much as on a stock that is worth 110, because it is always the par value of a stock that is referred to, and not the selling value.
Before the above Call expired, Union Pacific had advanced to 66, at which price we closed the contract by receiving the stock from the maker of the contract at 43, giving our check for $4,300 and selling the stock in the market for 66, the holder of the contract receiving the difference. A statement would be as follows :
||March 29th, 100 "0. P. sold C6, less 1/8 Commissions
||March 29th, 100 U. P., called at 43
|| $2,287 50
||Deduct cash paid for Call at 43 and Commissions
|| 106. .25
||Profit on the transaction
The Put That Paid A Profit Of $781.75, On Investment Of $106.25
Tumbridge & co., Bankers and Brokers, 2 "Wall st., N. Y.
The Use of Put Contract
Consider as you learn option trading that a put contact is the very reverse
of a Call—the holder having the right to deliver stock to the signer
of the contract at a fixed price before its expiration. The maker of the
contract is the only party bound, so that when advantage
is taken of the contract and a delivery of stock made, it is always profitable
for the holder of the contract. Consequently the market or actual selling
price of the stock when Put will be less than the Put price. If you hold
" a Put," viz, the right to deliver Jones 100 shares of stock
for which he agrees to pay you $4,500 and you can buy that stock in the
market for $2,500, it is very clear you make the difference between $2,500
and $4,500. Therefore, when Puts are bought, a decline in the market is
expected, and the profits are made from the decline. The details of a transaction
of this kind, such as furnishing the money to buy the stock, and making
the delivery to the signer of the contract, is always carried out by your
broker. The last few years puts have resulted very profitably. Every time
the market has advanced it has been follow d by a greater decline.
Lake Shore on May 8th, 1875. was selling at 72. We find by referring to our books that one of our customers bought-a Put on 100 shares of this stock at 70, for thirty days, for which he paid $106.25.
The following is a copy of the Contract:
The stock declined during May, to 57f but the contract was not closed until the day of its expiration, when the stock was selling for 61, at which price we bought 100 shares and delivered