Richard, my opinion is that any trading of this type should be public and transparent, but it isn't.
"
By E.S. Browning and Aaron Lucchetti
Staff Reporters of The Wall Street Journal
Not so long ago, corporate treasurers who used company resources to buy or sell stock options, in a bet that
the company's stock would rise, would have been called gamblers or worse.
But in today's bull market, so many companies are betting on their own
stock, through options, that they now consider the practice prudent financial management. Intel and
Microsoft both say they have made hundreds of millions of dollars with options.
The bull market has kept most -- but not all -- of the options trading
profitable. This month, bad news drove down the stock of biotechnology company Cephalon, raising
questions about whether it ever will profit from a $10 million options bet.
While such trading is legal and the Securities and Exchange Commission has allowed it to proceed, some
corporate boards consider it too much like gambling and refuse to go along.
A few years ago, using options to bet on your own stock "seemed a little seedy and suspect," says James J.
Angel, a finance professor at Georgetown University in Washington. "Now, they're seen as legitimate
risk-management tools."
At least 100 companies have used options to bet on their own stock,
according to a Salomon Brothers report in February. They include Intel, which claims to have pioneered the
practice about six years ago, Adobe Systems, Cadence Design Systems, Dell Computer, Dow Chemical,
General Mills, Interneuron Pharmaceuticals, Maytag, McDonald's and Microsoft.
Marketing the instruments and handling the trades has become big business at securities firms including
Goldman Sachs, Merrill Lynch, Morgan Stanley and Salomon Brothers, at Citibank and at the securities arms
of two big Swiss banks, Swiss Bank and Union Bank of Switzerland.
Some companies, including Boeing and International Business Machines, have tried the system, made money
on it, but abandoned it. Although they won't say why they quit, their decisions came around the time that
companies such as American Express used options in 1995 and 1996, but stopped doing so this year, for
reasons it won't discuss.
Conservative boards sometimes fear shareholder lawsuits if they lose money, and worry that the maneuvers
haven't been tested through the full cycle of a bull and bear market. But Kathy Fothergill, manager of investor
relations for Dow Chemical, says that options "may be risky for you and me as individuals, but for
companies and professionals that deal with this, it can actually mitigate risk," notably by reducing the cost of
stock buybacks in a rising market.
Much corporate options trading is in fact linked to buybacks. Companies either sell puts or buy calls in their
own stocks, generally at a stock price close to the market at the time of the option sale. With a put, the
company promises to buy back the stock if its price falls below the option exercise price; a call entitles the
company to buy its own stock cheaply if the price rises.
The advantage of a put is that the selling company immediately pockets a payment of as much as 10% of the
stock's value. If the stock rises, the put expires worthless and the company profits. If the stock falls,
however, the company must buy it back at an above-market price. It loses money if the decline is greater than
the proceeds of the option sale. With a call, if the stock price rises, the company can buy at a discount. If the
stock price falls, the company loses the cost of the call.
Maytag sells puts and then buys its own stock if the puts are exercised. Since the put is set at a price level
where the company once was ready to buy the stock anyhow, some companies maintain that it isn't really
painful to buy the stock even if the stock falls more than the premium amount.
Some boards will authorize puts but not calls, says a finance official at one big company, who has tried and
failed to win permission to buy calls. Puts theoretically involve greater risk of loss than do calls, since the
company must cover any decline in the stock's value. But puts don't seem as risky because they bring in cash
proceeds, while calls require an advance payment.
Some companies worry about insider trading or regulatory issues if they trade options. But the Securities
and Exchange Commission in 1991 issued a letter to the Chicago Board Options Exchange indicating that it
wouldn't object to companies selling puts on options exchanges.
But some experts worry about abuses. "As the option nears maturity, the company has incentives to manage
the flow of information," worries University of Rochester finance professor Clifford Smith. "I'll look at the
news that comes out before the options' expiration with a grain of salt."
SEC general counsel Richard Walker says that corporate options trading does open the possibility of abuse,
but that the SEC prefers to investigate any possible abuses rather than try to restrict the trading.
Intel trades only in puts. And with Intel stock up more than 15-fold since the start of 1991, "only a very few"
of the puts have ever been exercised, says Intel treasurer Arvind Sodhani -- meaning Intel has profited
handsomely. Today, Intel's outstanding puts represent more than $1 billion worth of stock, and it has received
more than $420 million in option payments since the program began.
Microsoft says it has made about $300 million after tax on a similar
put-selling program. None of the puts has been exercised.
Cadence Systems, another software company, uses still another approach. It started buying calls in 1994, to
reduce buyback costs in a rising market. But to avoid shelling out money for the calls, Cadence financed them
by selling puts. Traders call that a "cashless collar." If its stock falls, Cadence must pay off. Otherwise, it has
free call options. Cadence has bought back about 20 million shares using its calls, out of a total of about 45
million shares that
it has repurchased, and so far hasn't had to pay off on any puts.
For accounting reasons, software concern Adobe Systems can't reduce the total number of shares outstanding.
It may buy back stock only to balance new shares it issues to employees exercising stock options, and it uses
cashless collars to fund those buybacks.
Some companies that don't want to launch buyback programs still use options to try to profit from their
stocks' expected gains.
Cephalon, anticipating Food and Drug Administration approval for myotrophin, a drug to combat Lou
Gehrig's disease, bought call options on 10% of its outstanding stock. It hoped to profit when its stock
soared, and use the money to help fund the cost of commercializing the drug. But an FDA advisory panel last
week recommended against approval, and the stock sagged. Unless it recovers before the options' Oct. 31
expiry, the company will be out the $10 million in stock it used to buy the options.
Another biotech company, Interneuron, which considers its stock undervalued, also has bought calls from
Swiss Bank in hopes of raising money. But to reduce risk, it funded the purchase by selling calls, which
mature later, also to SBC. It hopes to profit from its stock's gains, and then later issue new stock to over the
cost. If its stock doesn't go up, it pays nothing. One risk: if the stock goes up later than Interneuron expects, it
could miss out on using the calls it bought, but still have to pay off on those it sold.
---
Bets by the House
More companies are buying and selling options in bets that the stock price will rise. Some sell puts,
obligating them to buy the stock at a preset price, risking losses if the price falls. Others buy calls allowing
them to buy their own stock cheaply if it rises.
INTEL: Has received $423 million in proceeds for selling puts and rarely had to pay off. Currently exposed to
puts on $1 billion worth of stock.
MICROSOFT: Has made $300 million after tax on puts and never had to pay off. Currently exposed to puts
on $2 billion worth of stock.
BOEING: Sold puts beginning in October 1992. Ended program at end of 1994 without explanation.
IBM: Sold puts once in mid-1990s to hedge a convertible debt security. Won't say why it hasn't continued." |
