Wall Street Week with Louis Rukeyser; 1620; At the Chicago Board Options Exchange

Back. At. Wall Street Week With Louis Rukeyser brought to you by a public television stations and by Hilton Hotels America's business address and its subsidiary Conrad international hotels competition makes American business Xcel Prudential beach securities the investment firm with rock solid resources that's leading the way to the Future for Investors and Unisys Sperry and Burroughs joined together form Unisys providing advanced information processing for government business and defense Unisys the power. To. From the Chicago Board Options Exchange. Produce Friday November 14. Our panelists are Louis Holland and the British get Murphy.

Believe me I'm with the guys or this is what we welcome back. Appearances to the contrary. This is not the scene after the last race at Belmont. All that clutter all those rip tickets all the mementos of financial triumph and despair just a few anguished hours ago were produced by a gamble of another sort. A bet on the future of the stock market. But this is the only ex trading pit at the Chicago Board Options Exchange. And it is here for the last three years that raucously shoutin startlingly young men and women have built one of the most exciting immensely profitable and flamboyantly controversial innovations in the entire history of investing. The basis of the innovation is simplicity itself. An option month by month on whether stocks in general will go up. Or down. But is it of any genuine economic value

or is it in fact just the marginally more respectable version of a racetrack wager. Is it distorting the more traditional stock markets. Is it siphoning off badly needed capital that would otherwise be going into more productive investments. For that matter does such wild and frenzied activity. Really even deserve to be called investing. Tonight we'll take a closer look at this World Center of options trading in a building so filled with electronic gear and frenetic humans. That though it is situated in the financial heart of frigid Chicago it neither has nor needs any artificial heating equipment whatsoever. When you're hot you're hot. But before we examine what options trading is really all about. And whether there is some rational way for you to make a buck out of it let's see what else was hot in America this week. Certainly not the economy. Its thermostat continued to register distinctly cool with industrial

production unmoved from its sluggish level of a month earlier and retail sales taking a big dip. Primarily because of the end of cut rate fun and games in the auto sales rooms. There was a lot of heat to be sure on the international scene as President Reagan put on his firefighters hat in an effort to contain the damage of a policy toward Iran that drew criticism from such dangerous left wing radicals as George Schultz and Barry Goldwater. And left a global impression that U.S. foreign policy was now being conducted at the White House. By the Keystone Kops. Oh well Ron as Jimmy Carter might have put it I have told us so. But enough of international intrigue. Let's see what cookies were being pushed in Wall Street in the week just passed. And as the Dow Jones Industrial Average indicates the market had three reasonably good days out of five. But a 31 point drop on Thursday apparently accelerated once again by options and futures related activity

was the worst since September and was enough to make it a losing week. In the end the Dow was down by nearly 13 points for the week to close at eighteen seventy three point five nine. And for the first time in more than two months all our broader indexes followed the Dow downhill for moderate losses. All that sloppiness actually cheered up our elves and I watch their technical market index is now about as neutral as a little fellow's index can be. With nine indicators flat. And one positive. There wasn't much to cheer about in the gold and silver markets both were down or for fans of the U.S. dollar which languished in the knowledge that even its own Treasury Department doesn't love it anymore. But don't despair there was some more cheerful news this Ronald McDonald is 20 years old this month and exactly 14 years ago today the Dow Jones Industrials closed over 1000 for the first time ever.

But it might be when are we going to get to 2000. I think probably later this year or into the first quarter of next year when you know the market topped in the 1900s in July and again in September so there's some resistance fear. And we've been going up since the end of September. We're up 8 percent in the Dow so I think we deserve a little reaction as a certified technician. Technical underpinning to the market improving at this point after a sloppy week like this one. Well yes it does improve as the market goes down and I think that we'll get some better readings if this continues I'm estimating that we may break below 1850. I'd say roughly 25 45 at this point the breadth of the market which has been a serious problem since the first quarter of the year showing some improvement we're up 5 percent from that. And we start to get more volume in the market and during periods and that's positive for the group. Well there's there's quite a cross-section really all from from the autos like Ford and Chrysler. To the lumber companies

wire houses Louisiana Pacific some of the gas utility companies Tenneco there are a number of stocks and groups brokerage stocks particularly are attractive right now too showing a lot of interest. We couldn't be in Chicago without mentioning Lou Holland is the only Wall Street analyst who was ever running back in the Rose Bowl or who ever played for the Chicago Bears who was briefly a running back for the Bears in 1967 before deciding he could make more money in other activities. So in your own hometown. Tell us what you think of this market this week. Well Lou Incidentally I might add that while you never really were the fridge you were a couple of pretty fast moving ice cubes. Thank you Lou. Well despite all the hoopla that we've been hearing for the last several months with regard to the tax bill program trading and the merger mania that's been going on the last several weeks really the market's been in the topping process for the last seven months. I mean we've been trading

roughly a 10 percent range or 150 points really since April and I think this prop topping process is comparable to what we had in mid 1983. And if you recall that topping process was followed by a fairly significant decline. I think some time in 1987 after in fact we make new eyes which I believe we will. I think we could see a decline of 15 to 20 percent I think sometime during 1987. You're going to see the market below 7500. President says we're bottoming you say we're topping. You too can make a pretty good wage and I probably know how little I know you also follow interest rates closely if the market's going to do as badly as you suggest. Does that mean a poor economy and as i mean lower interest rates. I think we're going to have an environment of lower interest rates. Lou and I continue to favor the financial stocks. I think the economy is going to remain relatively weak. And that's why I think we have a relatively good chance of going to new highs here with regard to the market. But I do believe we're in a topping process and I guess while in

fact I'm still bullish on the secular trend of the longer term trend of the market. I think that we're going to have a meaningful correction before in fact we do have good markets in 1998 99. Well you two have really shown us why it's possible to open the markets every Monday morning. Now before we meet tonight's special guest let's take a look at an investment vehicle that's no mystery to them though it has been called the security world's best kept secret. It's the option of the 45 million Americans who own stocks less than 10 percent have ever bought or sold an option and only 20 percent of the nation's brokers have ever written on options or. Options come into basic Variety calls and puts. And options player can be a buyer or seller of either a call gives its buyer the right to purchase 100 shares of a particular stock. Specific price within a set time period which can range anywhere from one to nine months. The stock goes up. So look all the push is

exactly the opposite vein instead the option to sell a particular stock at a fixed price during the life of the player. If the stock goes down. The put. With it right to sell above the market will go up before 1973. All options were traded over the counter which made it difficult for the average investor to sell an option at its fair market price before it expired. Then here at the Chicago Board Options Exchange listed stock options were introduced originally with Coles only on 16 stocks. Despite initial skepticism and Wall Street options trading as much. Today puts and calls are traded here at the CBOE on 161 different stock and options on about 300 more stocks are now traded for others. Along the way the CBOE added options on foreign currencies. But its most successful innovation came on March 11 1983 with the introduction of index options in

effect a call are put on the entire market 83 percent of all index options which expire on a monthly basis. I traded at the CBOE at an average of almost 500000 contacts a day. The local version was originally called the CBOE 100 but is now known by its ticker symbol x. An acronym for Options Exchange index. You know we x is now the most widely traded of all options accounting for 63 percent of overall volume here more than all other types of options combined. Depending on your personal goals you can either hate or speculate. When you pay the premium for no we x or any other type of. Head you choose options to protect their stock portfolio and guard against short market decline. Speculators in contrast zero in on that major advantage of options and leverage with options. An investor whose eyes are bigger than his wallet can control a large amount of stock for several months at

relatively little cost. But he also risks losing his entire investment since an option is a wastin asset unlike stocks which are issued by corporations. Options are merely the creation of the options exchanges and once expires. What is the impact of the option on the stock market and is this a game we individuals truly can or should play. My special guest and I both acknowledged experts on options. Jim Porter runs the largest clearinghouse for options in the country first options of Chicago. Earlier he was in the thick of the action here and on the Pacific Stock Exchange. Willis Morgan heads P.S. quote a Chicago based company that offers instant stock an option in quotes and portfolio analysis to personal computers and for the past 13 years has been a charter member of the CBOE. Jim let us start with you. Many people think they run the casino here to see you know that threatens legitimate investing is there in fact any merit to that charge.

I think there are opportunities to speculate a marketplace and some investors do choose to use it that way. But we have a vehicle here which can be used over an entire spectrum of investment requirements by investors. I understand that some think you know the impact on the rest of the stock market. What is the effect in your judgment. I think it's a derivative product. The effect has been been overly emphasized and in my opinion it is not driving the market but has added substantial liquidity to the marketplace. So in the end this is wonderful for stocks of options in your view. I think it is good. What are some of the benefits of some of the never would think of buying or selling an option might get from the fact that this is going on here in Chicago. Well they now have a vehicle which they can apply it with a lot of variety gives them a lot more flexibility in what they can do in the marketplace. They can generate income. They can transfer risk is what the main overhead but somebody is not in the options market. What's that doing to his or her stocks. Oh that this activity is going on here I think is generating more liquidity.

I think one thing people don't realize there is that auctions in stock are traded in tandem. The traders for example on the trading floor made a lot of stock and they're doing that to hedge option positions that they're taking during the during the trading day. So you think it reduced the up and down movements of common stocks. I think it has a tendency to to do that at times as a matter of fact we felt that they were stabilizing him too much and they were fixing stock prices at the strike prices. That phenomena seems to have gone away. Now the Dow is more than double We don't hear that so much. That's true. Morgan Do you agree that it's really a wonderful thing for the average investor that this activity goes on here in Chicago. Well I think the very success of the exchange and other option exchanges have pretty much proven that it's an effective investment vehicle and has proven to be an effective risk transfer mechanism for everyone from a professional investor to the very smallest private about what extent is this activity the reason why we've had such tremendous One-Day movements in the market in recent months. Well I think the there's a tendency

to blame a lot of the big moves on derivative products futures options things like that but I think if you really look at the total complex of investment vehicles available everything from the future down through the stock their money flows in and out of the complex and I think you'd find that I'm not an economist myself but I think it's probably a zero sum game there and it would have gone up or down anyway. Jim you emphasize that it could be used very conservatively option tell us how a conservative investor would use options. Well a method of using transferrin risk can be to sell an option covered right is a very common use strategy by investors. Also the fact that you can indeed limit your downside risk you can quantify somebody watching this program. I've never bought or sold. You've said that even a conservative investor could use and give them a couple of specific things they might do.

If you already hold a stock you could you could sell an option to generate income enhancing the the dividend return of the stock in addition to that you can hedge against a downside move in and and the market or in that particular stock by buying a put. Lou Morgan how much of your activity now is centered in the index up in the air we x when I'm active. That's my primary active this week. Not very. I've been working on my company I've been up stairs most of the time and I have to come down for a trading fix every once in a while. You have an opinion on this market. Yeah I do I have to I think agree with Bernadette. I think that it's obvious that there's a big tax overhang everyone knows that there's a lot of stock for sale so it should go down. So it probably won't markets never does well I mean you're a buyer of X options. We have schools before I came over here I looked at the call options in particular on the index and they've been beaten down to prices that I think indicate almost that people believe the market

won't ever go up again which is usually an interesting time to start looking at call options the wildest use of options as Gemma suggested is buying an option without owning a stock. And you've suggested you spend all your time on the index options But suppose somebody would think you have some hot stock option. Your only suggestion for them some of the speculative bent and adequate risk capital. Well not necessarily a hot stock option but how about someone with a speculative bent. That is looking for trade. And let's take a high quality stock that's been beat up a little bit like IBM. Everyone knows the earnings are soft things like that stock substantially off its high. There are some interesting interesting call options slightly above the current price. They have someone venturesome using money that he can afford to lose might be able to position himself. And if IBM were growing I think you'd have a pretty good return. How is that different from betting at the blackjack table in Caesars Palace. Well I think the blackjack table

the odds are like 1 and a half percent against you and I think if someone takes the time to study the market study the tools that he's got available to him he should be able to do better than average. And you don't have to do a lot better. Jim do you have any strategy advice at this moment. Well I was kind of agreeing with Lou that. The market seems to been a ranger for a while and my opinion it could move either way either above breakout to the upside or a significant correction. I would be inclined to look at a straddle and some of the more you explain why that is. This would be a position where you would buy a call and a put you could buy them at the strike price. Both of them or I might be more inclined to buy an ace. We call a strangle in the business or a combination might buy out the money call and now the money put a call higher than the market is now and a put low in the market is now a theory that will be terrific volatility but you're darned if you know which way is

going to go. That's correct and as long as the market doesn't stand still you might make a little money. That's right and if you stand still you'll probably lose it all. Well before we lose it all let's talk to two excellent panel and women do you every expiration day. There are hundreds of options that expire worthless. Now if somebody owns a coral or point at what point in the life cycle of the option should they start reviewing. Their holding. To see where its time is running against them and the value of the option is going to deteriorate. Burnet I think that's a really good point about options trading is that when you decide you're going to trade options you're making a commitment to to constantly review that because the option has a very short lifetime compared to most of the other investment vehicles that we have. So you are making a commitment to look at it frequently make decisions often you have that option to do now which you didn't have if you just take the

old buy and hold. Strategy is as your lazy man's way to profits in the past doesn't work with options. So I would review it. Almost daily see if it still fits into the particular. Strategy that fits my needs. What I'm trying to accomplish. Lou about 80 percent of the activity any in the major exchanges are represented by institutions. And we've had an ever increasing amount of institutional activity with regard to options and futures and I guess the question looking at it from an individual point of view is do I really have a chance with most of these institutions playing around with these big program trades. I mean do I really have an opportunity to make any money in that kind of environment or what would you suggest I do in that kind of environment. Louis you've got as good a chance as you ever had and possibly better and the institutions are following their own strategies and they're here they're here in size but

by their being here and being involved in the underlying securities they're also making the market more efficient so that you or any other private investor can take advantage of that efficiency and therefore narrower markets and follow his strategy with lower transaction costs or lower and lower trading costs. And you should be able to get more effective. Results than you would have without the institutions here. And I think again the history proves that in the early days here we didn't have the institutions and you could drive a truck through the markets. Well following up on that Lou is that your experience of the institutions or the individuals in general are wiser buyers of calls puts. I don't think one is particularly wiser than the other loo each one again is following his own strategy. It's an interesting market in that both could be right. Both both sides of a trade can win. In this particular situation Jim following on what Bret

asked you with all these options expiring worthless isn't it true that over the years the sellers of options on stocks they already own have been far more profitable than the buyers of options on stocks that in. I'm not sure I can confirm that. I saw no cases where that's not been the case. Well I know people who hit the lottery too but in terms of the average customer is most of the money made conservatively in this market. I think it is. I think most of the money is is made by people that really do spend the time to understand the market. Learn learn how the vehicles work and try to avoid risk rather than take risk. If someone despite all the cautions we've been giving to size a real hard options trader and are going to make a little bit of money go a long way and get rich before St. Swithin's Day. How much money they really need to get stored in this market is a traitor. And I think if you talk to the firms they have they have very strict garments. I find that in talking to one firm they have a requirement of 20000 rather than 15000 minimum now than 25 I think. I think the average It looks like it's around the 20000

level is what the firms require. They do have a requirement also for your income level Foca one firm has said they require their investors to have a $40000 a year income and a net assets of over $200000. Do you use computers for your own work. Yes I do. Is it possible to trade often without using computers. Yes I certainly think it is. I would suggest having access to a professional that has tools available. But again the efficiency of the market makes. What do you do what do you do in your computers. What does it tell you whether something is cheap or expensive compared to other options. Yes we do extensive theoretical value analysis of the options using standard and advanced statistical models and then determine that one or more options are overpriced. Others might be under priced and we construct either a trade or ahead using that and then follow through on that strategy. Is it your view that the index options are going to force out the individual stock options if it means taking over most of the

fighting. I think you're certainly correct in that but I don't think I don't see it forcing out the individual stocks there will always be interest in various stocks. Certainly it's been a little more sporadic but as a stock becomes active itself I think you'll see substantial option activity. I do agree. What do you think the next great innovation here in this innovative city of Chicago. Nash I wish I knew I hope it's a new options product. On our same time there we do have to stop. I want to thank my guest importer and Lou Morgan and my panelists for helping us all to better understand our options. Thanks to the good hosts and good sports here at the CBOE. Next week we'll be back in the more familiar precincts of all weans Mills Maryland where my guests will be a whiz kid who is applying some age old secrets to investment success he's Don W. Rogers doing are you just 28 years old but he's as a young track record as president of a capital management firm that's already growing respectful attention. So come join us as He reveals those age old secrets. Meanwhile

this event last week. I'm with you guys or good night from my kind of town. Wall Street Week With Louis Rukeyser has been brought to you by a public television station and boy will people tell America's business address and its subsidiary Conrad International Hotel competition makes American business to excel. Prudential beach security the investment firm with rock solid resources that's leading the way to the Future for Investors and Unisys Experian Burroughs joined together to form UNICEF is providing advanced information processing for government business and defense if you misuse the power of two. We're good friends. With this program.

Send through dollars through transfer. Wall Street owns wills Maryland. 201 so. That's $3 US to transgress. For St.. Johns Rosemary. Only Ron Ron Silver. Maryland resident. We said. It. Was three weeks transcript saucily. To subscribers of the boundary retrieval. Wall Street which is produced by American Public Television which is still being responsible for its gun. Here's something for viewers of Wall Street Week With Louis Rukeyser to order your 1987 financial calendar call 1 800 3 3 1 1000 and it did end with an introduction by Louis Rukeyser. It highlights exchange holidays option trading deadlines and release dates of economic indicators. It also includes a glossary of Wall Street terms and explanation of the TMI a personal investment ledger and more. All 450 95 plus $2 handling piece or MasterCard accepted That's 1 800 3 3

1 1000. All right.