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Understanding Put and Call Options Understanding Put and Call Options HOW TO USE THEM TO REDUCE RISK IN YOUR STOCK MARKET OPERATIONS by Herbert FilerINC.• NEWYORK © 1959 BY HERBERT FILER LIBRARY OF CONGRESS CATALOG CARD NUMBER: 59-14028 MANUFACTURED IN THE UNITED STATES OF AMERICA Seventh Printing, July, 1965
Contents Foreword by Oliver J. Gingold The Offering of Special Options Straddle Option Uses of the Put Option Contract Buying a Put Option for Speculation Trading in Odd Lots Against a Put Option Trading Several Times Against an Option Buying a Put Option to Protect a Profit Buying a Put Option to Protect an Initial Commitment Special Tax Factors Covering Put Transactions Purchasing a Put Option to Maintain a Short Position Buying Stock to Make a Long-Term Gain and a Purchase Using a Put to Make a Long-Term Gain in a Declining Market 7 18 18 19 31 31 34 41 41 43 44 46 47 48 51 52 53 54 How Option Orders Originate Uses of the Call Option Contract The Use of a Call Contract for Speculation Closing Out a Contract for Partial Recovery Selling a Stock and Buying a Call to Maintain a Position The Use of a Call Contract for Trading Purposes Protect a Short-Sale at Time of Commitment The Use of a Call Option to Average Protect Profit in a Call by Buying a Put Buying Stock and Call at the Same Time Trading in Odd Lots Against a Call Buying Long-Term Calls for Tax Benefit The Renewal of Options The Exercise of Options Before Expiration The Effect of Options on the Stock Market Effect of Dividends, Rights, and Stock Dividends Percentage of Options Exercised "Years Ago" The Selling of Option Contracts Selling Call Options Against a Portfolio The Sale of Put Options Buy 100 Shares and Sell Straddle or Buy 200 Shares Selling Straddles Against a Portfolio Selling a Spread Option Sale of a Strip Selling a Strap Selling Call Options Against Convertible Bonds, Warrants, or Preferred Convertible Stocks
55 5S 59 60 61 62 64 65 66 67 67 71 74 75 75 76 78 80 9797 100 103 105 106 107 108 108 110 113 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. I have written numerous articles about options, including one for and at the request of the Encyclopedia Britannica, and the present edition contains that explanation of the uses of options. But in this book I propose to give the history of options and the various uses of the Put option contract, the Call option, and their variations and combinations such as the Spread, Strip, Straddle, and Strap. Now I will say simply that a Put option is an option to sell (or "Put") at a specific price within a specified time limit. A Call option is an option to buy (or "Call for") at a specified price within a specified time. These will be thoroughly explained shortly, as will Spreads and Straddles. I will show by example just how they can be used in market operations—their speculative uses and their protective or insurance features. I will show that the main advantage in the buying of options is the feature of limited loss and unlimited possible profit. I will also show who "makes" options and why, and the advantages accruing to those who write or make these contracts. Any disadvantages will also be pointed out, because there can be disadvantages if certain age-old principles are ignored. When I read a book on a special subject, I am curious 9 about how qualified the writer is to handle the subject; I suppose the reader might want to know my qualifications for writing this book, so here goes. Filer, Schmidt & Co., has dealt in nothing but options— "Options Exclusively"—for all these years. Options are not just a department of the firm. In 1932, when the Securities Act was being drawn up, the original attitude of the lawmakers was, ". . . not knowing the difference between good options and bad options, for the matter of convenience we strike them all out." At that point the entire option business was threatened, and by appointment of the Put and Call Brokers and Dealers Association, Inc., I had the privilege of appearing before a committee of the House of Representatives and the committee of finance of the Senate to defend the usefulness and economic value of our business in the securities market. Subsequently, the Securities and Exchange Commission was formed, and the option business was allowed to function "if not in contravention of rules set down by the SEC." In all these years the SEC has not found it necessary to lay down any rules to govern the business of Put and Call options. Almost all of the option business in this country is done by some twenty-five members of the Put and Call Brokers and Dealers Association, Inc. This association forms rules for the conduct of the business, polices the affairs of its members, arbitrates any differences between its members or between its members and the public, and reports each week to the Securities and Exchange Commission a list of option trades made by the members of the association. While the options traded through our members run into millions of shares annually, there is rarely a matter which comes before our Board of Arbitration, and seldom is an error made in making a trade. ized. Of course, during the years of World War II, there was no trading on the European exchanges, for they were then closed. However, since the end of the war there has been trading on such exchanges where currency is free (for instance, in Switzerland), and today we do considerable option business between New York and Switzerland. It might be of interest to the reader to know that on the London Exchange, where option trading had been discontinued since the war even though securities, as such, weretraded, the members voted overwhelmingly for options, and actual trading was resumed in October, 1958. London options, however, are different from American contracts in many respects, the two important differences being that options can be traded only between members— not the public—and London options cannot be "done," as they term it, for periods over seven account periods (approximately ninety days). In the United States we do a large part of our option business in six-month options and, occasionally, trade in contracts for one year. And our contracts can be bought or sold by members of an exchange or the public. Options are used daily in real estate transactions, and such use is explained here in an attempt to draw a parallel, as near as possible, between options on stocks and options on real estate. abandon its plans and its loss would be limited to the cost of the options acquired. As another illustration, let us suppose that Mr. Jones wants to sell a piece of property for $100,000, and Mr. Smith believes that he can sell it to Mr. White for $125,000. Mr. Smith wouldn't want to buy the property and then find that he was unable to sell to Mr. White. So for a relatively small sum he buys an option from Mr. Jones, good for 90 days, to buy the property for $100,000. If, within the 90 days Mr. Smith is successful in making the sale to Mr. White for $125,000, he then exercises his option and buys the property from Mr. Jones according to the terms of his option contract, and sells it to Mr. White. Mr. Smith has made $25,000, less the cost of his option. If, however, he had been unable to sell the prop- erty to Mr. White, Mr. Smith would have allowed his option to lapse and his loss would have been limited to the cost of the option contract. Options are used extensively in many businesses today. A ball club has an option on a player, a movie studio on an actor or actress, and you can even choose your own option as to how you wish to have your life insurance paid to your heirs. Webster's Dictionary gives these definitions of "option": (1) The exercise of the power of choice.
(2)
Power of choosing:the right of choice, an alterna
(3)
A stipulated privilege of buying or selling a stated
(4)
The right of an insured person to choose the form in In the case of Put and Call stock options, the choice or "option" belongs to the holder of the option contract; he can exercise his contract or not, according to his choice, and he will exercise the option at or before its expiration only if it is to his advantage to do so. The seller of the option has no choice; once he has sold the contract, he must accept stock or deliver stock according to the terms of the option and only at the option of the one who holds the contract. Arbitrage—Purchasing in one market for immediate sale in another at a higher price. Hedge—To counterbalance a sale or purchase of one security by making a purchase or sale of another. Colleges and universities have begun to realize that this subject, which is part of Wall Street procedure, could well be included in a course on finance. I feel that the information gained through such education will stand the students in good stead when they enter the business world, particularly the field of finance. It is not my contention that everyone must trade in options, but I do say that anyone who has an interest in securities should have a knowledge of Put and Call options because at some time or other options can play a part in one's security-trading, whether to protect a profit or possibly to recapture stock after taking a profit. nineteenth century, options in this country acquired the names of "Puts" and "Calls," and they have been dealt in in increasing numbers ever since, for those who deal in securities recognize both their protective and their speculative value. Of course a man wouldn't think of owning a home without insuring it against fire; nor would he think of not insuring his wife's jewelry and furs against loss or theft; he carries life insurance to protect his family when he dies. Yet it is strange that relatively few people understand that through Put and Call options they can protect themselves against unlimited loss in stock-holdings, or can preserve substantial "paper" profits without selling. Many of the large losses, either of invested capital or "paper" profits, sustained by traders in the bad breaks in the market that come every now and then, could have been avoided through the protection that is available through options. It has been my experience that small stock-losses do not break a man, but it is the large loss taken by the stubborn trader in a market like that of 1929, 1937, 1946, or 1957 that can wipe out a trader or leave him with little chance to recoup his losses. Now seems to be the time when options are needed in the field of finance more than ever before because they act as a protection against excessive losses and as a safeguard for profits. It should be made known to every investor and speculator that there is a way to guard against exces- sive losses by limiting such losses to a specified and relatively small amount. 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. The option contracts in which the members deal are transferable contracts, and on the back of each contract is the name of the stock-exchange firm where the individual or company that sold the contract has his account. This endorsement of a member firm of the New York Stock Exchange guarantees that the terms of the contract will be met. The contract is made out in bearer form and can be resold by one person to another. Option Contracts Option contracts are traded in units of 100 shares, not in odd lots, and they are made for periods of 30 days, 60 days, 90 days, 6 months "plus," and, occasionally, for one year. Puts and Calls are usually done "at the market." That is, the price at which the stock is selling when the trade is made. A Put or a Call on a stock selling at 50 would be made at 50 in the usual way of business. However, it is possible to buy or sell an option "away from the market," that is a Call at 52 when the stock is selling at 50 or any differential by agreement. The most popular contracts are those that run for 90 days or 6 months. A contract can be exercised at any time before expiration at the option of the holder. It is not necessary to wait until expiration to act on or exercise one's option. If a man owns a Call option at 50 which expires on December 10, and by November 20 the stock has risen to 60—at which point he would be satisfied with such a profit—he may exercise his option at that time. He need not wait until the expiration of the contract. The option money or premium is the amount paid for the contract. The amount paid for the option is not applied to adjust the price at which stock is bought or sold upon the exercise of the option. If you have a Call on stock at 70 and you exercise the option, you pay $70 a share for the stock less any dividends that accrue to the contract. If you have a Put at 70 and you exercise the Put, you receive $70 a share for the stock less any dividends that are due on the option contract.
A Put option is a transferable-bearer contract paid for by the buyer upon delivery of the contract, giving him the right, at his option, to deliver to the maker or seller of the contract a certain number of shares of stock at a fixed price on or before a stipulated date.
In the above contract the holder may deliver to the endorser of the contract 100 shares of XYZ common stock at 70 any time before the expiration date (August 20) at his option. expiration.
This is the reverse side of a Put contract and will be signed by a member firm of the New York Stock Exchange, guaranteeing to the holder of the Put contract that the stock will be accepted if the holder of the Put wishes to exercise his option.
CALLOPTIONCONTRACT A Call option is a transferable bearer contract paid for by the buyer upon delivery of the contract, giving him the right, at his option, to buy or "Call" from the maker or seller of such
contract a certain number of shares of stock at a fixed price, on or before a stipulated date. any time before the expiration date (August 20) at his option.
This is the reverse side of a Call contract whereon is put the endorsement or guarantee of a stock-exchange house guaranteeing to the holder of the Call that the stock specified in the contract will be delivered to him, at his option, upon presentation of the Call contract.
THIS IS A QUOTATION SHEET DATED MAY 25, 1959 traded in the over-the-counter market. Anyone interested in the buying or selling of an option can obtain quotations through his stock-exchange broker or directly from an option dealer. These quotes are nominal. Latest quotations should be obtained from your Stock Exchange broker, or directly from us. QUOTATIONS FURNISHED BT Filer, Schmidt & Co. ESTABLISHED 1919 Members Put & Call Brokers & Dealers Ass'n, Inc. THE PUT & CALL MARKET 120 BROADWAY, NEW YORK 5, N. Y. BArclay 7-6100 Allcontractsare endorsed by MembersFirmsoftheNewYorkStockExchange The following quotations are on the issues that are most active in the Option Market Other Quotations May Be Had On Request
Orders for these or other contracts can be placed directly with us "BUY FROM FILER, SCHMIDT & CO." State and Federal tax must be added to the cost of call options.
Quotations Subject To Change Without Notice. bearer transferable contracts endorsed or guaranteed by member firms of the New York Stock Exchange and can be sold or transferred at will, like checks. The law requires that New York state and federal tax stamps be affixed to Call options but not to Put options; stamps so affixed are the same as if the stock in question had been sold in the market. The tax is based on the selling price of the stock, but is never more than $12.00 for the combined federal and state tax per each 100-share Call. The New York state tax is as follows: On stocks— to each 100-share Call contract; 100-share Call contract. The federal tax is based on the dollar value of the stock specified as follows in the Call contract for each 100-share Call: Federal Tax $.04 per $100 value $.04 any fraction above ½ as an example: (.04/100.00 of $4000.00) $40.00 STOCK = $1.60 40 ½ " = 1.60 405/8 " = 1.64 50 ½ " = 2.00 505/8 " = 2.04 The combined maximum federal and state tax is $12 per 100-share Call. 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. The Offering of Special Options 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. The offerings may be limited in quantity and are offered "subject to prior sale or price change." Originally, these contracts are bought by an option-dealer in the expectation and hope that he can resell them. If the dealer holds a Call contract and the market favors him, he might very well be able to dispose of the contract at a profit. If the market declines, the option may prove to be a complete loss to the dealer, but this is a business risk that he takes.
THE ADVERTISING OR OFFERING OF SPECIAL OPTIONS 32 The converse of the Put option on U. S. Steel at 95½ which was offered when STEEL was selling at 94¾ is the Call offered in The Times ad on Jones & Laughlin at 715/8, running until August 21 for $650. At the time this Call was offered, the stock was selling at 75, or 33/8points above the Call price, and the Call had 82 days to run. In other words, the Call already showed a gross profit of 33/8 points. Compare such an offering if you will with a newly made 90-day Call contract at the then current market price of 75 which was offered for $525. To make a profit on the newly made option, the stock would have to advance above 80¼ (not counting stock-exchange commissions). To make a profit on the special Call, the stock would have to advance to 781/8- That is, 715/8 —the Call price plus the $650 premium paid for the option. Straddle Option Example: A Put contract at 60 and a Call contract at 60. The exercise of one contract before expiration does not void the remaining option. Example: Stock selling at 60 in the market. A Spread is a Put possibly at 58 and a Call possibly at 62. A Spread can be made at various distances from the market price, and the dollar cost price of the Spread contract varies with the Spread of the option prices. $400. The difference of $200 would represent half of the spread between 58 and 62. Straddle at 60 - Cost $600 Spread 58-62 - Cost $400 odd lots. Nevertheless, orders for 500- or 1,000-share options are common and orders for 10,000-share options occasionally come into the market. However, to buy options on such a quantity of shares is a job which the option-dealer must handle with care. To go to a seller of options and let him know that you have an order of that size would immediately arouse his suspicions and he would be reluctant to sell any options. So, in handling such an order, the option-dealer must try to fill his order 500 or 1,000 shares at a time, without disclosing the size of the full order. The same technique would probably be used on the floor of the stock exchange by a broker who had a large quantity of a stock to buy or sell. To disclose the size of his order would enable other brokers to "take the market away from him," and he would then be able to complete his order only by bidding the stock up in the case of a "buy" order or marking it down considerably in the case of a "sell" order. p.m. (New York time) on the date stated in the contract, and they cannot be exercised by telephone but must be presented to the cashier of the stock-exchange firm that endorses the contract before the expiration time of 3:15 p.m. (New York time). A number of stock-exchange firms who have bought contracts for their customers, to avoid loss, insist on having instructions for the exercise of options well in advance of expiration time on the day that the option expires. In order to eliminate the chance of loss in late presentation of an option and to avoid delay when a contract is to be exercised, contracts should never be kept outside of New York City but should remain with your stockbroker or your option-dealer for safekeeping. The maker of an option contract will not accept it if it is presented after it expires. When he sells the option, he agrees to live up to the terms of the contract but not beyond them. If the maker of a contract agreed to accept one presented two minutes after it had expired, he might be asked of an option, the following established rate will guide: For buying or selling 100 shares of a stock at $50 per share, the commission is $44; for buying or selling 100 shares of a stock at $75 per share, the commission is $46.50; for buying or selling 100 shares of a stock at $100, the commission is $49. In the closing or exercising of an option contract, by buying or selling stock in the market and exercising the option on the same day, the customer will be required to deposit with his stockbroker 25 per cent margin (instead of 70° per cent) or $1,000—whichever is higher—because such a trade is a complete and virtually riskless transaction. Some individuals who are far from an office of a stock-exchange firm or who have no account with one often do business directly with an option-dealer. The option-dealer will hold options for the account of a customer and will exercise the options upon instructions from the customer. of the Dealer's transactions less two regular stock exchange commissions and any applicable tax. No margin has been required because the customer will have sold the contract itself to the Put and Call Dealer. The customer who expects to buy options directly from 
"Federal Reserve fixes margin requirements which are changeable.
an option-dealer should make a deposit with his option-dealer to open an account and thereby avoid any delay in the execution of orders when he desires to buy an option. Any options bought by the client will be debited against his account, and any profit arising from the sale of a contract by a client to an option-dealer will be credited to the client's account. Most dealers ask their clients to send their orders by wire, collect, because if a client gets an idea that a stock is going to move and wants to buy an option, the delay in sending an order through the mail could make him miss the move. While option-dealers carry accounts for clients who want to purchase options, the making or selling of original Put and Call contracts must be arranged with a stock-exchange firm so that the contracts sold will carry that firm's endorsement. The option-dealer will be glad to help make such arrangements for those who do not already have an account with a stock-exchange firm but the option-dealer does not carry customers' securities and members of our association are not members of the New York Stock Exchange and cannot endorse options. In the purchase of options, timing is most important. Many times, the customer has good information but buys 90-day options or 6-month options, only to have the stock move just after his option expires. For that reason it might be well to consider the purchase of option contracts on the stagger system so that the expiration dates occur a week or so apart. Buy some of your options this week, some next week, etc., as far as you want to go, so that if the first set of options is bought too early, it is possible that those bought subsequently can prove profitable. It is also good policy to buy an option of longer duration than you think you need. If you think that a move may take place in 60 days, it is smart to buy an option for 90 days. The cost of the longer option will ordinarily be very little more. For many years prior to 1935, options were dealt in for periods of 2 days, 7 days, 15 days, and 30 days—rarely longer. The short-term contract is now quite obsolete-most of our current business is in contracts for 60 days, 90 days, and 6 months. The 6-month option is usually made for 6 months and 10 days to take advantage of the long-term gains provision of the tax law. The option business is a little different from the stock-exchange business. In the latter, if you want to buy 100 shares of U.S. Steel, you place your order with a broker who, through his man on the floor of the exchange, can buy or sell the stock in a matter of minutes. A ready market will be quoted, e.g., 691/2 bid offered at 70. That means that there is a ready market where you can sell stock at 691/2 or buy stock at 70. In the over-the-counter market, if you want to buy or sell an unlisted stock such as an insurance or a bank stock, a dealer in those issues will quote you a firm market and will trade immediately. Not so in the option business—here almost all quotes are nominal and subject to being filled, and every trade must be consummated individually and by phone. It may be that when an order is placed to buy or sell an option, as many as fifty phone calls will have to be made by the option-dealer before a trade is completed. He may have to make phone calls to Detroit or Chicago or anywhere in the country. Only through an option-dealer's knowledge of the business can he quote with any accuracy the market on any issue for an option, and only through this knowledge and his contacts can he fill his orders for options with the least delay. Contracts are sometimes offered "firm" for a few minutes and, occasionally, a contract will be offered overnight. The option-dealer usually keeps a file system listing clients who have signified that they have an interest in selling options on various issues, and it is this list of possible sellers of options that the dealer contacts when he has orders to buy either Puts or Calls. Uses of the Put Option Contract 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. The price of an option usually depends on the price of the stock, the duration of the option, the volatility of the stock, and supply and demand for the options in question. Buying a Put Option for Speculation option would cost, he might receive a nominal quote of, say, $350 for a Put at the market for 90 days. Most options are negotiated "at the market," which means at "the current market," when the option can be obtained by the option-dealer. Suppose that the stock is selling at 50 and the quoted price of $350 is satisfactory to you. You enter your order: "Buy a 90-day Put on 100 XYZ [the name of the stock] for $350." If you are trading through your stock-exchange broker, he will give your order to an option-dealer who will contact one of his clients who sells options on that stock and will attempt to buy the option for you. When, after this contact or several others, he has obtained the Put option for you, he reports to the stock-exchange broker who gave him the order, and he in turn reports to the customer: "Bought Put 100 XYZ at 50 expires December 30 for $350." Let us say that the man who bought the Put option, expecting a decline in the stock, was wrong, and that the stock, instead of going to 30 (as he expected), advanced to 70 and was selling there when his option expired. He would have lost the $350 that he paid for his Put option. Bear in mind that the limit of the man's loss was the cost of his Put option, or $350, no matter how high the stock rose and no matter how wrong he was, and that he would draw on the equity in his account to that extent only. Suppose, on the other hand, he had sold the stock short in the market. His loss would have been 20 points and still no knowledge as to the possible extent of loss until he covered the short sale. But in the purchase of the Put option his account would read: Bought Put on XYZ at 50 for 90 days: Loss $350 Remember, too, that no trade has been made in the stock, so no stock-exchange commission has been paid. A regular stock-exchange commission is charged by your broker only if a transfer of stock is made in connection with the option. On the other hand, suppose the man's judgment was correct and the stock declined to 30. If he had instructed his stockbroker to buy 100 shares at 30 and exercise his Put option, his account would look like this: Sold 100 shares at 50 (through exercise of Put) $5,000
Bought 100 shares in market at 30 3,000 Cost 350
Profit on trade $1,650 The profit then would be almost 500 per cent of the cost of the Put contract. The profit is the difference between the cost of the stock plus the cost of the Put option and the proceeds of the Put that was exercised. In all of these examples showing the use of options, the commission cost has been ignored. But at no time could the loss have been more than the cost of the option— $350—and any stock-exchange commissions would have been paid out of profit or out of possible recovery of part of the premium which was paid. Trading in Odd Lots Against a Put Option In the aforementioned example of trading against an option, the trading was done by buying 100 shares of stock 43 at 30 and selling the stock at 50 through theexercise of a Put option. Another way of operating against such a Put option is to buy stock in odd lots of, say, 25 shares each on a scale-down as follows: the holder of a Put at 50 might buy 25 shares at 36, 25 shares at 34, 25 shares at 32, and 25 shares at 30. Of course, each purchase in the market must be margined according to stock-exchange regulations, but the man who has no definite opinion as to where the stock should be bought against his option "scales" his buying orders until he has bought 100 shares, and then he may, if he cares to, deliver these shares against his Put option contract. His account would then read: Bought 25 shares at 36 cost $ 900.00 Bought 25 shares at 34 cost ........................... 850.00 Bought 25 shares at 32 cost ........................... 800.00 Bought 25 shares at 30 cost ........................... 750.00 $3,300.00 $3,650.00 Sold 100 at 50 through exercise of Put............. $5,000.00 Profit $1,350.00 Trading Several Times Against an Option Suppose that instead of expecting a severe decline, the trader expected that we would for the next few months have a market that would be a "trading market," one that would fluctuate mildly. The ability to use an option to trade against can be quite profitable to the holder, for many trades can be made against the same option, and each time a trade is made, that trade is fully protected against unlimited loss if the trader's judgment should be wrong. For example, let us say that a man buys a Put option on 100 shares at the current market price of 50 for 90 days for $350. In a few days the stock declines to 46, and the trader, feeling that the drop has been enough for the moment, buys 100 shares at 46 through this stockbroker. He must deposit the normal margin required for such a purchase as the option cannot be used for margin. In making such a purchase, he is guaranteed against loss because the holder of the Put option can, up until the expiration of the Put contract, deliver his stock at 50 at his option. Now he is holding 100 shares which cost 46, and since his Put option guarantees that he can sell it at 50, he is assured of no loss. Say that in the next week or so the market rallies and the stock rises to 51 and the trader decides to sell. To recapitulate: the trader bought stock at 46 and sold it at 51, yet he still retains his Put option, which does not expire for some 70 days. He has made a gross profit of five points and may have further opportunity of making additional trades—and each time he buys stock under the price of his Put during the life of his option contract, he is guaranteed against loss. 45 have another chance to take a profit. The number of opportunities to make such trades is limited only by the fluctuation of the stock in the market and the trader's ability to judge the stock's movements. The reader should realize that it might be possible to make many such trades during the life of an option. Note that a trade or trades against an option do not nullify the option contract. The contract is operable until it expires or is exercised. Buying a Put Option to Protect a Profit A man owns 100 shares of stock which he bought at 30 four months ago. Now the stock is selling at 50. Concerned about conditions but feeling that his stock can do still better, he buys a Put contract at 50, good for 90 days, for $350. I would like to call the attention of the reader to the fact that the $350 paid for the protective Put can easily be more than made up by the fluctuations of the stock in the next 90 days. On the other hand, let us suppose that when the Put expires, the stock has advanced to 70. While the buyer then allows his option to expire (he wouldn't Put stock at 50 when he can sell it in the market at 70) the 20 points appreciation in the stock has more than made up the cost of the Put. Only if the stock is at about the same price of 50 when the option expires will the $350 paid for the contract be an actual loss. Even then it must be admitted that the Put has furnished protection during the period of the option. Note that the holder of an option will and should exercise his contract even if the exercise will return to him only part of the cost. If the holder of a Put at 50 finds that at expiration the stock is selling at 48, or even 49, the contract should be exercised so as to recover part of the premium instead of losing all of it. Sold Stock at 50 by exercising Put .................... $5,000 Bought Stock in market at 48 ................................... 4,800 Profit on Stock....... $ 200 Loss between profit on stock & cost of Put Option . $ 150 Buying a Put Option to Protect an Initial Commitment 47 contract. To be practical, let us see what happens if the stock goes up to 70, as he expects, or what happens if he is wrong and the stock goes down to 30. In the first instance he would sell out his stock at 70 and let the Put option lapse, and his account would read: Bought 100 shares at 50............................................. $5,000 Bought Put 100 shares at 50-cost............................. 350 Total Cost .......... $5,350 Sold 100 shares at 70 .......................................... $7,000 Profit .................... $1,650 If he had been wrong and the stock had declined to 30, his account would have read: Bought 100 shares at 50 .......................................... $5,000 Bought Put 100 shares ...................................... 350 Total Cost............ $5,350 Sold 100 shares at 50 (through Put) ................... $5,000 Loss .................. $ 350 Note that he sold his stock at 50 (at cost) through the terms of his Put contract, even though the stock had declined to and was selling at 30. Special Tax Factors Covering Put Transactions 48 stock at 50 and at the same time he bought a Put at 50). The first type of transaction brings into play a special rule of the federal income tax law; the second type of transaction brings into play an exception to that rule. The special rule states that if a taxpayer makes a short-sale of stock and (1) if at the time of making the short-sale he has held the same stock for not more than 6 months, or (2) if, while the short-sale was open, he has acquired more of the same stock, there will be two consequences: First, any gain on closing the short-sale will be a short-term capital gain, even though the short-sale is closed by the delivery of stock that, at the time of delivery, has been held for more than 6 months. Second, the holding period of the stock that at the time of the short-sale had been held for less than 6 months or had been acquired while the short-sale was open, starts on the day the short-sale is closed. The length of time that the stock was held before the short-sale was made and the length of time it was held while the short-sale was open are ignored. In the first example, the stock which had cost 30 had been held for only 4 months when the Put was bought. If the taxpayer had made a short-sale instead of buying a Put, the special rule would have become applicable. Since the acquisition of a Put, under these circumstances, 49 is the making of a short-sale, such acquisition made the special rule applicable. If, when the Put expires, the market is 70 and the trader sells his stock at 70 at a time which is more than 6 months after the date of the acquisition of the stock, but not more than 6 months from the date on which the Put expired, his gain will be short term, despite the fact that he has actually held the stock for more than 6 months. If, however, he did not buy the Put until after his stock had been held for more than 6 months, the special rule would not apply for the reason that the conditions that bring the rule into play would not exist; i.e., the Put was not acquired at a time when stock had been held for not more than 6 months nor was any stock purchased while the Put was in force. Consequently, any gain on the sale of the stock, whether from a sale in the market (at a price above the price in the Put) or delivery upon exercise of the Put, will be long term. If, when the trader buys a Put on 100 shares, he has two lots of the same stock—100 shares which he has held for more than 6 months and 100 shares which he has held for not more than 6 months—a peculiar situation comes about. If the trader exercises the Put, he must be careful which lot of stock he delivers. If he delivers the lot which has been held for more than 6 months at the time he purchased the Put, he will have a short-term gain on the exercise of the Put; and if within 6 months of exercising the Put he sells the other lot, he will have a short-term gain on the latter sale, also. This unusual situation comes about as follows: one lot of stock has been held for not more than 6 months. If the trader had exercised the Put by delivering the lot which had been held for not more than 6 months at the time of the purchase of the Put, the gain on the closing of the short-sale would still be short term but he would be left with the lot that had been held for more than 6 months; this lot would not have lost its holding period, and when it was later sold, the gain would be long-term. Purchasing a Put Option to Maintain a Short Position 51 these funds. How can he withdraw these funds from his account and still profit by a further decline of the stock? If he covers the stock that is short, he will no longer need margin for that short sale, and he can withdraw his funds. He then buys a Put option at 50 (the market) for 90 days for $350.00. If before the expiration of the Put option the stock declines to 30, he buys stock in the market at 30 and delivers it against his Put contract at 50. He has accomplished two things—he released the margin that he needed for his business or something else and through his Put contract was able to share in the further decline in the market—all with the risk limited to the cost of the option. This operation brings to mind the oft quoted adage: You can't have your cake and eat it—but in this case you can. Buying Stock to Make a Long-Term Gain and Protecting the Commitment In other words, if the stock is selling at 50 and you buy 100 shares of stock at 50 and at the same time (that is, the same day) buy a Put good for over 6 months, you are allowed to carry the stock fully protected by the Put for the duration of the option (of course, the stock must be properly margined). If at the end of 6 months and a few days the stock has risen to, say, 75, you can sell out your stock, and your profit is long-term gain. In this case, the holding period of the stock is not affected by the purchase of the protective Put option. If, on the other hand, by the expiration of the Put the stock has declined to 30, you exercise your Put at 50, and your loss is limited to the cost of your Put option plus stock-exchange commissions and taxes. In this case you have had an opportunity to make an unlimited long-term gain with a risk limited to the cost of your option and commissions. How else could you have an opportunity to make a possible unlimited profit with a small limited loss? A Put Option vs. a "Stop-Loss" Order to Protect a Purchase Mr. B., on the other hand, buys 100 shares at 50 and at the same time enters a "stop loss" order at 46. Such an order becomes an order to sell only if the stock sells at 46, and then it becomes an order to sell at the best price obtainable. If such an order is executed or "touched off," Mr. B. will probably get 46 or less for his stock—a loss of about $400 and he is out. His loss is greater than the cost of the Put option which Mr. A. bought, and he cannot benefit when the stock rises to 60. See the difference? Using a Put to Make a Long-Term Gain in a Declining Market profit, that profit would be a short-term gain. The only way that a long-term profit can be made in a falling market is through the purchase of a Put option good for over 6 months and the sale of the contract itself after it has been held over 6 months if the decline in the stock in question is great enough to show a profit. As an example: he has held for over 6 months and the profit will be a long-termcapital gain. The option-dealer will exercise the contract for his account and will sell the corresponding stock in the market (in the case of the Call), or will buy the stock in the market (in the case of a Put). The purchase price which the option-dealer will pay will be equal to the net proceeds of the dealer's transactions less two regular stock exchange commissions and any applicable tax. How 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 Explanation of Chart U.S. STEEL A look at the accompanying chart of U.S. Steel common shows that it broke from 72 in the second week of July, 1957, to 48¼ by the third week in December of the same year. From 48¼ it rose in almost a straight move to just under 100 in January, 1959. In the examples that I use as illustration, people might say that I am using only favorable ones. I am using not only examples of options that were profitable to the buyer but also those where the buyer of the option was wrong and lost his premium money. Some of the examples are taken right from the records and are options that were actually sold at the time and at the price mentioned. On July 23, 1957, when U.S. Steel was selling at 70½, 6-month-and-10-day Puts were sold at 70 ½ for $475 per 100-share Put. The Puts expired on February 3, 1958, and on that date the stock sold at 56. The Put contracts could have been closed out on that date with a profit of $1,450, less the cost of the option and commissions for buying and selling the stock. Of course, during the life of the option, the stock sold for as little as 48¼. Had the holder of the option seen fit to close out his option in mid-December, he could have bought stock at 49 and exercised his option before expiration, showing a profit of $2,150. Even if the man's judgment of the market had been wrong—but it wasn't—his loss would have been limited to the cost of the Put option. If someone had been farsighted enough to buy Calls on U.S. Steel in mid-April, 1958, when steel was selling at 56, his profit could have been enormous. On April 16, 1958, Calls were sold at 57 5/8, expiring in 6 months and 10 days (October 27, 1958), for $450 per 100-share Call. On October 27 the stock sold at 87, and if the Call had been closed out on that date, the profit would have been $2,937.50, less the cost of the option and stock-exchange commissions for buying and selling the stock. The owner of such a Call does not necessarily have to sell the stock after he Calls it—he may see fit to Call it and carry the stock, looking for a higher price at which to sell it. Of course, in calling the stock and carrying it, he will be required to margin the stock properly with his stock-exchange house.
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Total Receipts $5,000
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. The option-dealer might quote the contract at a nominal price of $400. This quotation is sent back to the customer in Detroit, and if the quotation meets with his approval, an order will be given to the option-dealer to "buy Call on 100 XYZ at market for 90 days for $400." On receipt of such an order, the option-dealer will get in touch with his clients who might be interested in selling such a contract, and when he has been successful in negotiating the trade, he will report to the stock-exchange firm from whom he received the order: "Sold you Call 100 XYZ at 70 for 90 days for $400 expires October 24." The Call option contract is then delivered to the stock-exchange firm which gave the order and the latter will pay for the contract from the customer's account and hold the contract, subject to instructions by the customer before expiration as to whether or not the option should be exercised. (The cost of federal and state tax will be added to the cost of a Call option. There is no tax required on a Put option.)
If the customer wishes to have the option exercised and it happens to be a Call on XYZ at 70, his instructions to his stockbroker will read: "Exercise Call on 100 XYZ at 70 expiring October 24 and sell stock at market;" or if he wishes to exercise his Call contract and carry the stock in his account his instructions should read: "Exercise Call on 100 XYZ at 70 expiring [date] and carry stock in my account."
Of course, if he chooses to carry the stock, he will be obliged to margin it according to stock-exchange requirements. If he exercises the Call and at the same time sells the stock, he will be required to deposit only 25 percent
Uses of the Call Option Contract
The Use of a Call Contract for Speculation
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50, is going to have a substantial rise. He buys a Call option on 100 shares at 50, good for 90 days, for $350 plus tax. The federal and state tax departments demand that tax stamps be affixed to Call options (but not to Puts). This tax, paid for by the buyer of the option at the time he buys it, is the same amount that would be paid by a seller on a sale of the stock at the Call price. The maximum is $12 per 100 shares and is fixed according to the dollar value of the stock involved. When the trader buys the Call option at 50, good for 90 days, for $350, this amount is the most he can lose, no matter what happens to the stock. If the trader is correct in his judgment and the stock rises to, let us say, 70, before his Call contract expires, he buys the stock by exercising his Call and sells the stock in the market at 70. His profit is $2,000 less the cost of the Call contract, and his account shows:
Bought call 100 XYZ at 50 for................... $ 350
Bought 100 shares at 50 thru Call................ 5,000 $5,350
Sold 100 shares at 70 ................................... $7,000
Profit.............. The transaction shows a profit of almost 500 per cent of the $350 at risk.
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is to his advantage to do so. The seller or maker of the contract has no choice—he must live up to the terms of the contract at the option of the holder of the contract.
Closing Out a Contract for Partial Recovery
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.
His account would read:
Bought Call XYZ at 50-cost................................ $ 350
Bought 100 shares a/c Call ................................ 5,000
$5,350
Sold 100 shares in market 52............................... $5,200
Loss.................... $ 150
(For simplification Stock Exchange commissions have been omitted.)
Selling Stock and Buying a Call to Maintain a Position
needs the money in his business. However, he does not like to lose his stock position. He might consider the following: He sells his stock at 50, releasing his funds, and at the same time buys a Call option at 50 good for 90 days at a cost of $350.00. If the stock advances, he exercises his Call and thereby re-acquires his stock. He may then sell the stock that he acquired through the Call and take his
profit, or he may care to carry the stock at 50 which is now selling in the market at 60. If, on the other hand, the stock declines to 40, he lets the Call option expire and now he can, if it suits him, re-acquire at 40 the stock that he sold in the market at 50. Through the Call contract, he accomplished two things—he released the $5,000 that he had invested and also had control over the same number of shares for the duration of his option, and at the same price that he sold them.
The Use of a Call Contract for Trading Purposes
Suppose a trader bought a 90-day Call option at the current market price of 50, for which he paid $350, and that the contract was to expire on December 31. Let us also suppose that some time in October the stock rose to 55, at which point the trader sold short 100 shares. This short-sale—and it must be sold as "short" stock—must be margined with his stock-exchange broker, but at this point the trade is risk less. The trader has a 5-point profit less the cost of the Call at any time that he cares to exercise his option. But he doesn't care to exercise his option because it has about 2 months to run and the fluctuations in the market price of the stock in that 2-month period may give him additional opportunities to trade. Let us say that after having made the short-sale at 55, the market declines in another week or so to 50, where Mr. Trader sees fit to buy in or cover his short-sale. His account now looks like this:
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Sold 100 shares at 55.............................. $5,500
Bought 100 shares at 50............................................. $5,000
Cost of Call Option .................................................. 350
Total Cost .... $5,350
Profit .................... $ 150
But the Call runs until December 31, and the trade which was made does not nullify the option. In another week or so, because of some news, the stock rallies to 56, where Mr. Trader again sees fit to sell short. Again he has a riskless, profitable transaction, and in a week or so the stock again declines to 50, at which point the short-sale is covered. On this trade another profit of $600 is added to the $150 already made.
Sold 100 shares at 56 ....................................... $5,600
Bought 100 shares at 50 ......................................... 5,000
Profit................... $ 600
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a profit. Just as a Call can be used to protect a trade for trading purpose, Call options can also be used to:
Protect a Short-Sale at Time of Commitment
A man feels that a stock now selling at 50 will decline and sells 100 shares short in the market. Not willing to risk an unlimited loss if the stock advances, he buys a Call option at 50, good for 90 days, for which he pays $350. He is now guaranteed through the terms of his Call that he can buy 100 shares at 50 at his option before the contract expires, so if he is wrong, his loss will be limited to the cost of his Call option.
Now let's look at the operation both ways: Let's see what happens if the man is right and the stock declines and if he is wrong and the stock goes up instead of down. If the stock should go down to 30, as the man expects, he covers his stock in the market at 30 and takes his 20-point profit. Naturally, he won't want to exercise his Call option to buy stock at 50 because he can buy it better in the market, so he allows his Call option to lapse. He:
Sold 100 shares at 50 .......................... $5,000
Bought 100 shares at 30................................. $3,000
Bought Call at 50 ..................................................... 350
$3,350
Profit.............. $1,650
One might say that he could have made the short-sale without having spent $350 for the protection. Certainly— but suppose that instead of the stock going down to 30, it had gone to 55, 60, 65, and then 70. What then? How far do you let your loss run? Well, some would say, why not sell the stock short and put a "stop loss" order in at 53½?
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If the stock declined to 30, he would have saved the $350 and his profit would have been $2,000 instead of $1,650. That's fine, but suppose the stock rose to 54 first, stopped out the man's short-sale with a loss of $350 or $400, and then declined to 30. His original idea was correct—the stock did decline to 30—but the stop-loss order for protection was more costly than the Call option. If he had had the Call option, the rally to 54 would not have worried him because he would have been guaranteed through his contract that he could cover at 50, but the stop-loss order caused him a quick and definite loss.
The Use of a Call Option to Average
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he sold both the stock that had cost him 40 and the stock that had cost him 20, which he had on Call, his account would look like this:
Bought 100 shares at 40 .................... $4,000
Bought Call 100 shares at 20 .................... 225
Bought 100 shares at 20 a/c Call................ 2,000
$6,225
Sold 200 shares at 35 ................................... $7,000
Profit.............. $ 775
Protect Profit in a Call by Buying a Put
Or, say that in the remaining 30 days of his Call, the stock continues to rise and goes to 80. He then has a profit of $3,000 less the two premiums of $750, or a net profit of $2,250. This treatment can be varied by the purchase of two Puts instead of one.
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The uses of options are limited only by ones ability and ingenuity.
Buying Stock and Call at the Same Time
A stock is selling at 50. and the man buys a Call at 50 on 100 shares for 90 days for $350. At the same time, he buys 100 shares in the market at 50 (which he must margin). If the stock advances to 55 in a few weeks and he sells his stock, he has made $500, less commission, which will about pay for the Call option. Now he has his option at 50 the stock is selling at 55 and the Call cost him nothing, with some time for the Call still to run. From here until the time the contract expires, he may trade to his heart's content above the Call price for he has his Call as protection. He may sell short at 60, cover at a lower price, then sell again and cover again as long as there is a profit. If the stock goes up after a short sale, he can always use his Call to cover his short sale.
Trading in Odd Lots Against a Call
their orders to sell against an option which they hold. For instance, take a man who owns a Call option on 100 shares at 50, good for 90 days, for which he paid $350; his idea of trading is to sell 50 shares short at 60, and maybe
Explanation of Chart
CHRYSLER
Take, for example, a man who bought 100 Chrysler on August 20, 1957, at 80. By November 20 (or in 90 days) he would have had a loss of $1,400, and in 6 months his loss would have been $3,000. Compare his position with that of a man who bought a 90-day Call contract on 100 Chrysler at 80 on August 20, at the market for $500. Let us suppose also that this last man bought a 6-month Call at 80 on August 20 for which he paid $750. Neither the 90-day Call nor the 6-month Call would have shown a profit. The man who bought the Call options was as wrong in his market judgment as the first man, and he lost the money that he paid for the Calls—but that money was the limit of his risk. Now, after Chrysler declined, the man who had bought the Calls instead of the stock and had drawn from the equity in his account only the cost of the Call contract, was in a position to buy the actual stock at a much lower price than when he first became bullish on it. Even though the purchase of the Calls was unprofitable, it saved him from buying the stock at the original high price.
As another example, suppose a man was bullish on Chrysler in the third week in July, 1958. The stock, according to the chart, sold at 46½. At that time he could have bought a 90-day Call contract at 46½ (the price at which it was selling) for $350. During the life of the Call the stock advanced, and in the third week in October, when his Call expired, the stock sold at 58. He could have exercised his Call at 46½ and at the same time sold the stock at 58, thereby making approximately 11½ points, less the cost of his option and commission for buying and selling the stock.
The records show also that 6-month-and-10-day Calls were bought on October 24, 1958, at 53½ for $600 per 100-share Call, when the stock was selling at that price. On May 4, 1959, when the Call expired, the stock was selling at 68, showing a profit of $1,450, less the cost of the Call and stock-exchange commissions for buying and selling the stock.
Long-Term Profit $1,500
Sold stock in market at 70 ............................. $7,000
BANKERS AND BROKERS, 2 "Wall St., N. Y.
SUGGESTIONS.
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.
Our long experience in stock operations gives us many advantages, and coming in contact with the great stock manipulators, we are often 
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 
Extensions or renewals must be secured before the expiration of the original contract.
Register all mone letters, send large amounts by express or draft on New York, and address all communications
