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Technology Stocks : Stock Swap -- Ignore unavailable to you. Want to Upgrade?

To: V. who wrote (10871)	1/24/1998 11:11:00 AM
From: Patrick Slevin	Respond to of 17305

Stocks, Commodities, and Options. I see we are trying to turn this into a high-end YK2000 discussion, are we? Okay, take this bit of information from "The Doctor" at the CBOE. ~~~~~~~~~~~~~~~~~ Point number one.....Stocks and commodities essentially offer the identical payoff. The payoff is linear and if you graphed a P/L you would gett a 45degree line. In cash markets...stocks/commodities you have only three choices....LONG>>SHORT>>OR CASH. The user of a futures contract is shooting for the payoff of the cash instrument(THE STOCK>>THE BOND>>THE PHYSICAL COMMODITY>>>THE INDEX....WHATEVER). The future provides leverage and has all the costs bundled into the price and this would be viewed as the future's premium. A cash instrument with a $100 value and a 5% carry would have a future with a fair value of 105. If the cash instrument paid a cash flow(dividends on stocks as an example)of say 2% the future would have a fair value of 103. Short term inbalances would cause the future to trade at prices other than the expected "103". If an effective cash andd carry arb can be done with the future vs the cash you would have pretty good pricing of the future...ie S & P, BONDS, etc. Where the cash and carry is difficult...oil, lumber, etc you get poorer pricing and accordingly poor price discovery. Options are all the above plus more, but they have a cost. Buying a call and selling a put on a stock IS THE STOCK EXACTLY with the cost of carry bundled into it. So first anything you can do with Stock or a futures contract you can do with option.....Now some disstortions may exist as to margins..upticks...trading rules..limits etc....but you can do the same stuff...EXCEPT with option you can do more. You could buy a call instead of going long the underlying...BUT WITH OPTIONS THERE IS A COST. THAT COST HAS TWO COMPONENTS> CARRY and Volatility...these add up to what is called time premium. 100 Stock 5% cost of money 2% dividend a year call would cost at least $3.00(depending on streike)if it representted a 100 shares. That $3 would arise from the carry on the stock. The call would actually sell for more than $3..the difference is the premium paid for volatility(and imbedded in that premium is the limited risk feature). A snapshot of this volatility premium would be the price of the put,,,which is a measure of risk. Carry + Put = Call an instrument with limited risk and unlimited upside. OPTIONS GIVE YOU OPTION(I should have sservicemarked that years ago), BUT ACCORDINGLY THEY COST MORE. With Options you can create almosst any expected risk/reward payoff you want. Options aloss provide a way for a society with capital markets to TRANSFER RISK from parties who don't want to parties who will acccept it..in essence you create an insurance market. NO one instrument is superior or more wholesome. They are both different andd similar. In good markets where all there exist and trading friction is low it becommes very very easy to trade and to facilitate everyone from small traders to large traders...PROBABLY THE TEXTBOOK MARKETS ARE THE OTC FX and the US 30 year bond...although the German BUND is getting close....and come to think of it the CBOT is thinking about a bigger 30 year contract...but I'm digressing. ~~~~~~~~~~~~~~ Had enough yet?