Home  |  Get Started  |  Download  |  Advertise  |  Donate  |  Contact Us
Option Trading Strategies Sitemap

Foreword - Options are probably as old as history. The early Phoenician merchants, and later the Romans, sold what we would term "options" on the goods in their incoming argosies. Later, some three centuries ago, options were used in various ways in Holland and became an important factor in many markets.

Use of Options - It is strange that a business, which has been in, existence as long as the business of stock options has never been fully explained, except in leaflet form. As far as I can learn after searching through libraries and college reference books, no complete book has ever been written explaining all of the uses and facets of the business.

Option-Dealers - Practically all the orders for the purchase and sale of Put and Call options come to New York, where they are executed by members of the Put and Call Brokers and Dealers Association, Inc. As previously explained, this association consists of approximately twenty-five members who deal exclusively in Put and Call options, and all of the options in which these members deal are guaranteed by member firms of the New York Stock Exchange.

Holidays - Options are never made to expire on a known holiday. The contract will be made to expire on the next business day after the holiday.

Besides arranging for the purchase and sale of new options on order, some option-dealers carry an inventory of option contracts which they offer for resale through newspaper advertisements, as on page 32 or by quotation sheets sent through the mail.

Uses Put Option - In all of the following examples, for the sake of better understanding, I will try as much as possible to use one figure for the price of the stock and one figure for the cost of the option. Understand, please, that these prices change in actual practice. The cost of an option on a stock selling at 50 would be less than one selling at 80 and, likewise, the cost of an option for 90 days would be less than one for 6 months on the same stock.

Special Tax Factors - In the two preceding examples, the trader bought a 90-day Put option. In the first example, he was protecting an unrealized profit of 20 points (he had bought the stock at 30 and four months later, when the stock was at 50, he bought a Put at 50). In the second option he protected himself against loss on a new commitment (he bought the stock at 50 and at the same time he bought a Put at 50).

Option Orders Originate - Before going into the further explanation and application of options, it might be interesting to explain how orders for options originate and are executed. An interested party—perhaps in Detroit—will ask his stockbroker to ascertain on what terms a Call option can be had on a certain stock for, let us say, 90 days. The stockbroker will find this out through his New York office, which in turn gets in touch with an option-dealer for the terms on which a Call option can be had on that particular issue.

Closing Out - The preceding example of a Call contract for speculation showed a handsome profit. Suppose that when a Call option at 50 was about to expire the stock was selling at 52. While the holder of the Call contract could not recover all of his premium of $350, he could, nevertheless, Call for his stock at 50 and sell it in the market at 52, so instead of losing the $350 premium, he would recover $200 of it. -

Protect Profit - Here's a tricky one but very useful. A man bought a 90-day Call at 50 (stock was selling at 50) for $350. In 60 days the stock rose to 70. At this price of 70 he has a 20-point profit, less the cost of his option, and he buys a 60-day Put at 70 for about $400. Let us see what happens. Say that in the 60-day life of his Put the stock declines again to 50. He has lost the profit that he had on his Call, but he has a 20-point profit on his Put, less 2 premiums totaling $750-a net gain of $1,250.

Long-Term Calls - The idea in finance today is to make money, true; but how much money net? What's left after tax? For that reason people look for long-term capital gains on which the tax is 25 per cent maximum. A man in the upper income tax bracket may have to pay a tax of 75 per cent or 80 per cent on his ordinary income, but the same amount of long-term capital gain calls for a maximum tax of 25 per cent. Instead of making a dollar, paying 75 cents in tax, and having 25 cents left, one is better off making only 50 cents on a long-term capital-gains basis, paying 12½ cents, and having 37½cents left. Therefore, in any form of capital asset, people look for capital gains opportunities.

Options Exercised - I can remember when I testified before the Senate Finance Committee in 1934. I was, of course, younger and less experienced, but 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.

Selling of Options - I remember lecturing in Chicago some years ago, and after this talk, during a question-and-answer period, one of my audience said, "I have bought options, but I never knew I could sell them." Well, for every trade—whether in options or clothing or real estate—there must be both a buyer and a seller. It is usually very interesting to my audiences to learn where options come from, who makes them, and why. I'll try to explain the selling of options, the advantages to the seller, the disadvantages, and the pitfalls, for I said at the outset that I would show the good side and the bad.

Selling Straddles - The owner of 100 shares of a stock may be willing either to buy more shares of the stock or to sell out at a premium. In such a situation he can sell a Straddle. A Straddle, as previously defined, is a combination of a Put and a Call, both at the market price of the stock. Let us say that a man sold a Straddle on XYZ at 50 for 90 days, and for it received $500 per 100-share Straddle. By selling the Straddle, he has contracted: (1) to sell 100 shares at 50 any time within 90 days when Called by the holder of the Straddle; (2) to buy 100 shares at 50 any time within 90 days if the holder of the Straddle Puts stock to him.

Appendix - Under the Internal Revenue Code of 1954

Revenue Ruling 58-234 and Other Rulings in Effect May 19, 1958

Prepared by Brach, Gosswein & Lane Certified Public Accountants

© 1958 Put & Call Brokers & Dealers Association, Inc.


Add URL | Contact Us | Privacy Policy | Option Trading Strategies Sitemap | Resources
COPYRIGHT (C) 2005 www.optiontradingstrategies.org