Options markets try to make amends for some big investor losses in October

Options trading on Oct. 20 and 21 experienced an unusual 48-hour period, Peter Thayer recalls. ``We were buying low and selling new options at lower prices,'' says Mr. Thayer, the vice-president at Gateway Investment Advisers Inc. in Milford, Ohio. ``We were shaking our heads and wondering how anyone could be paying so much: There were strange transactions at prices that were totally unrealistic. No one knew where the prices were'' that week.

Thayer, also the manager of the Gateway Option Index Fund, says he wrote one call option contract for $17 at noon on Oct. 23. By 3 p.m. the price had fallen to $10. ``We'd made half a million dollars,'' because of the number of contracts purchased multiplied by the $7 profit on each one, he continues. ``And the stock market wasn't moving.''

The Gateway fund has shares of all 100 stocks in the Standard & Poor's 100 stock index and sells stock index options to hedge against market volatility.

An option is the right, but not the obligation, to buy or sell a security for a fixed price within a certain time. A ``call'' option gives a person the right to buy, while a ``put'' option gives the buyer the right to sell.

During the week of the stock market's 508-point plunge Oct. 19, volatility in the markets made it difficult for marketmakers in stocks and options to set prices for shares and contracts.

Losses in options trading on Oct. 19 and 20 have been estimated at many hundred millions of dollars, leading to a higher than normal number of complaints from investors who felt they were overcharged for their options contracts during those wild trading hours.

Last Wednesday the American Stock Exchange (Amex) said its specialist firms that trade options would return about $1 million of their own money to certain investors. Earlier in the week the Chicago Board Options Exchange announced it would refund up to $1.2 million to investors in nine series of the S&P 100 stock index options contract.

The CBOE, the nation's largest stock index options market, will probably raise the money through a trading transaction fee. Disgruntled investors usually try to get back losses from brokers or traders through arbitration proceedings.

``We're trying to adjust prices that may have fallen outside the normal range,'' an Amex spokesman explains.

In the months after the market's plummet, trading in Major Market Index options of 20 blue chip stocks on the Amex had fallen 60 percent, but in recent weeks it has picked up, the spokesman says.

The exchange had received 50 percent more complaints than it normally does, specifically about options trading on Oct. 20. In its recently released report on the stock market's plunge, the Securities and Exchange Commission said the performance of marketmakers in stock index options was inferior.

``It's a first step,'' says an options trader at a Wall Street firm, who asked not to be identified. ``It won't make people whole by any means, because you can't correct the mispricing. And the market as a whole lost half a trillion dollars. Every member firm lost money in options, but a more equitable number would be huge.''

Thayer of the Gateway fund says he does not think the exchanges' efforts will have much of an effect in bolstering investor confidence. ``It's nice from a public-relations point of view, but it seems they're trying to head off the investors at the pass and stop lawsuits that could be coming in. But while trading may have been chaotic, it wasn't fraudulent.''

Setting prices during those days was difficult, because the marketmakers used a formula that included a calculation for volatility.

``These were not normal times, certainly,'' the trader says. ``But in my opinion, options were grossly overpriced.''

On the stock market, the Dow Jones industrial average closed up 72.78 points last week, at 1,983.26.

About these ads
Sponsored Content by LockerDome

We want to hear, did we miss an angle we should have covered? Should we come back to this topic? Or just give us a rating for this story. We want to hear from you.

Loading...

Loading...

Loading...

Save for later

Save
Cancel

Saved ( of items)

This item has been saved to read later from any device.
Access saved items through your user name at the top of the page.

View Saved Items

OK

Failed to save

You reached the limit of 20 saved items.
Please visit following link to manage you saved items.

View Saved Items

OK

Failed to save

You have already saved this item.

View Saved Items

OK