The Offering of Special Options Part 1

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 above are advertisements offering special options. The one on the left is from The New York Times and the one on the right from the Wall Street Journal, both of the June 2, 1959, issues.

The contracts shown in the above advertisements are offerings, not bids. Here is the explanation of exactly what the ad means: the first item under "Put Options" means that on receipt of $700, the option-dealer will deliver a Put contract giving to the buyer of the Put (the purchaser or anyone to whom he transfers the Put) the right to deliver or sell to endorser or guarantor of the option 100 shares of U. S. Steel at 95^½ any time before December 8. At the time of the advertisement, the stock was selling at 94%, so the Put option was ¾ of a point above the market price. At the same time, a newly made 6-month Put option at the market price of 94¾ would have cost about $750, so by comparison, the Put at 95½ for $700 was more attractive, since the obtainable price was $75 higher and the cost of the option $50 less. Comparison should be made between regular market options and special options that are advertised, and option-dealers, when asked to quote a price for an option, usually offer special options if they are available.

Stock Trading Puts and Calls

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 33/8 points 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.

Notice that special options are usually offered at a price different from the market price of the stock. Newly made contracts are usually made at the market price of the stock at the time the contract is arranged.

Straddle Option

A "Straddle" is a combination of a Put and a Call option sold for a single price. The premium is paid by the buyer at the time the contract is made. The Straddle gives the holder the right, at his option, to sell the maker of the contract the stated number of shares of the specified stock at the stated price before the specified date and also the right to receive and buy from the maker the stated number of shares of the specified stock at the same price before the same date.

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.

A "Spread" is similar to a Straddle-a combination of a Put and a Call contract-except that where a Straddle is a combination of a Put and a Call at the same price, the Spread is a Put at a price below the current stock-market price, and the Call is a price above the current stock-market price.

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.

The Spread is less expensive than a Straddle on the same stock for the same length of time by approximately half the difference of the spread between the Put and Call. For example, if a Straddle at 60 were to cost $600, a Spread of two points up and two points down would cost $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

Options are dealt with in units of 100 shares-never in 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.

Most option business is done in stocks listed on the New York Stock Exchange, some in stocks listed on the American Stock Exchange, and a small part in securities traded in the "over-the-counter" market. While options cannot always be negotiated on every stock on the exchange, the number of stocks on which options are written includes most of the leading stocks and also enough additional issues to satisfy a large demand.

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