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