Terry S. Maness

The impact of options on the underlying securities

12 0 ptions have been the most dynamic seg1

Rewards to Extending Maturity

ment of the securities industry since the advent of the Chicago Board Options Exchange (CBOE) in April 1973, which was followed shortly thereafter by four other registered option exchanges. The dynamic growth of these markets can be attributed to innovations such as the standardization of contractual terms and the creation of a central clearing corporation to serve as issuer and obligor of each option contract. These changes have facilitated the trading of existing options in the secondary market and provided increased liquidity, reduced transaction costs, and continuous public reporting of prices, trading volume, and open positions. The success of these markets may be measured by the volume of option contracts traded on the five registered exchanges versus the volume on the OverThe-Counter market. The highest volume year in the Over-The-Counter market was 1968 when contracts representing approximately 30.3 million shares were traded. This compares with contracts representing 5.5 billion shares traded in 1978 on the five exchanges, an increase of 181-fold. In fact, CBOE trading volume on one April 1978 day exceeded by 33% the total annual option trading of the Over-The-Counter market in 1968. Moreover, option trading volume (number of option contracts traded times 100) generally exceeds the trading volume of the underlying securities. This tremendous growth of options activity over the past few years has caused the industry itself, the exchanges, and also the Securities and Exchange Commission (SEC) to be concerned about the effect of option trading on the market for the underlying securities and on other segments of the capital markets. It is the purpose of this study toinvestigate the longer term ?a impact of registered option trading on the risk-return posture of the underlying securities. If a significant difference were found, it might suggest the possibility that option trading could have an effect on the allocational efficiency of the market for the underlying securities. We will begin with a brief review of other studies concerning the impact of option trading on the underlying securities; we then outline the statistical methodology and data utilized in the study; the next section reports the empirical results; and the final paragraphs summarize the findings and offer some concluding remarks.

Nonspeculative Behavior and the Term Structure

University in Wac0 76798-8004). hat are the average expected rewards to extending the maturity (or duration) of a fixed-income portfolio? Do rewards increase monotonically with maturity? How large are the average rewards? Do rewards vary predictably through time, and, if so, what variables appear to be able to predict the rewards? And, what are the investment implications of these questions? We examine bond returns, forward rates, and institutional evidence to try to answer these questions. We conclude that the preferred habitat theory best explains the pattern of average term premiums (i.e., returns in excess of returns on a short-term risk-free asset). Average term premiums rise with maturity through about three years, become essentially flat from three to perhaps fifteen years, and fall thereafter. The largest rewards to risk are earned for extending maturity through six months and nine months. One-year bds earn most of the maximum average term premium. A novel conclusion is that term premiums decline at the long end of the bond market. We present evidence from several sources to support this position. We also summarize the evidence on the predictability of term premiums. Several stuhes conclude that a long-short term spread the spread between long-term and short-term bond yields can predict term premiums. When the term spread is, respectively, wide, narrow, or negative, bond term premiums tend to be generous, negligible, or negative. We show that an intermediate-short term spread does a better job than a

Short-Term Financial Management

There are two well-known distinct aspects to the behavior of a risk-averse individual towards a risky proposition: the position he takes, long or short, with regard to the gamble, and the scale of the position taken–the amount by which he goes long or short. On one hand, the first aspect depends only on the individuals assessment of the expected return from the gamble relative to a safe return. The second aspect, on the other hand, will be influenced by the individuals degree of risk aversion and the level of risk of the gamble.