From: blenko-tom@CS.YALE.EDU (Tom M. Blenko)
Subject: Re: Warrents
Reply-To: blenko-tom@cs.yale.edu
Organization: Yale University, Department of Computer Science, New Haven, CT
Distribution: usa
Date: Tue, 17 Nov 1992 04:56:45 GMT


| >>>
| I don't get it. Options are insurance policies. Options
| on options are reinsurance. What is the objection to
| either, and why shouldn't they be traded as securities?
| <<<
| 
| The idea of insurance is fine; the problems arise when one starts  
getting
| enough options volume so that the options must be considered as  
commodities
| (items in their own right), rather than as a minor cost associated with
| stabilizing a portfolio.  In such a case, the amplifying effect of  
options
| can be very dangerous.  Consider a bull market, where people are  
speculation
| (not hedging, speculating) in options by buying calls.  If for some  
reason
| a bear market, even a minor one, occurs, a great many people may find  
that
| they have lost ALL of their money--not just the one-fourth or one-third  
they
| would have lost if they'd been holding the stocks.  Under the right
| circumstances, this may trigger selling, and turn a minor bear into to
| major one.

I think you've described some of the effects of
speculative investment on the market. Speculative
investment, however, doesn't begin or end with options,
so I don't see it as an argument against options. It is
true, I think, that small and inexpert players can get
hurt -- but again, they don't need options to do that
(witness the messages here following up on "hot"
information gleaned from 60 Minutes broadcasts). 

| This problem is yet another case of the more general economic problem  
that
| is usually seen with credit, but is more correctly termed a problem of
| unsupported expectations.  In stable or predictable (which generally  
means
| good, i.e. UP UP UP) financial markets, people gradually lose sight of  
the
| fact that bears do come wandering buy, and spend/invest ahead of their
| guaranteed means.  (Think of all those people who thought that house
| prices would rise forever.)  When the market goes bad, a whole slew of
| people--possibly even a majority of the investing public--are suddenly
| faced with the realization that they are in way over their heads.   The
| result is a precipitous drop in their spending, and possibly other
| money-saving activities (in the extreme case, bankruptcy), which has the
| effect of disrupting the smooth flow of capital in the economy.  The  
result
| is a degree of turbulence which, if it gets bad enough, can take down
| even prudent businesses and individuals, as well as those who were
| speculating.

Look, individuals engage in leveraged speculation all
the time -- it's called getting a mortgage to buy real
estate. You are quite correct that one effect is
increased volatility in the markets. We happen to be in a
period when a lot of people are getting burned by this. But
I think that mortgages and investment in real estate
aren't going to go away, for perfectly good reasons --
there is an economic cost to prohibiting these
alternatives as well. 

And I don't see any argument here against options in
particular.      

	Tom
Newsgroups: misc.invest