The Use Of Options

Percentage of 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.

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, Mr. Pecora, after other questions, asked me the percentage of options that were exercised, and I told him that about 12˝ 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 12˝ 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?

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