Stock Crash Shows Volatility of Securities Markets / Losses Numbered in Millions

Article excerpt

NEW YORK - The stockmarket's collapse on Oct. 19 showed once again the potential volatility of the securities markets.

It demonstrated to the thousands of options traders around the country that this investment device can be among the most volatile of all instruments in these markets, even for those who use it in conjunction with other strategies.

On that day and the days immediately following, options purchasers who had bet that stock prices would rise suffered losses totaling many millions of dollars.

The most visible sign was the $90 million write-off taken by an affiliate of the Continental Illinois Corp., largely as a result of options dealings of six investors who were said to have sold out-of-the-money ``naked'' put options. For them and for others, the relatively small gain from the sale of the contract was overwhelmed by an enormous loss.

``The one thing October proved is that the market and individual stocks could move a lot more than you ever thought they could,'' said Peter W. Thayer, executive vice president of Gateway Investment Advisers, a money management firm in Cincinnati. ``The most speculative thing you can do is just buy, or just sell, put or call options.''

An option is the right, but not the obligation, to buy or sell a security at a fixed price within a fixed time - typically three, six or nine months. A call is an option to buy, while a put is an option to sell.

The seller, or writer, of the put or call is paid a small fee, known as a premium, by the purchaser. That fee is determined by supply-and-demand forces in the marketplace, just like current stock and bond prices.

The writer of a call contract is betting that the market will remain level or turn down and that the buyer will not want to exercise his right to purchase the underlying security from the writer because it would be at a higher-than-market price.

In a put contract, however, the writer is betting that the market will stay level or turn up and that the purchaser will not want to sell his security at the contract's price because it is lower than the market price.

In both cases, the writer profits by the amount of the premium paid by the buyer.

If the market turns down in a put contract, though, the purchaser will exercise his right and the put writer must buy the shares at the higher contract price.

Puts and calls can also be either ``naked'' or ``covered.'' In a naked option, the writer has no offsetting positions, whereas covered options are contracts backed by the shares underlying the options.

- In a covered call, for instance, the writer of the contract owns the security that he may have to sell to the buyer if the buyer exercises his option right.

- in a naked call, the writer would enter the contract without the security in hand and would have to purchase it in the event the contract buyer exercised the right. …