Spread And Straddle

A "spread" is a privilege to combine a "put" and a "call" contract. The holder of a "spread" has paid for a privilege for a certain time either to deliver a stock at a stipulated price to the maker of the contract, or to call upon him for the stock. In buying a "spread" contract the purchaser expects to profit through a large advance as well as a decline. In either case, should the stock pass his contract price, he could execute his "spread" and take his profit, figured on the same basis as illustrated in the "put" contract. Should the stock both advance and decline within the contract period to a favorable point of execution, the holder of a "spread" would doubly profit, but should it touch neither figure, then he is out the money the "spread" has cost him.

A "straddle" is not unlike a" spread" contract, except that it is made at the market and the execution of either one of its privileges nullifies the other. The "straddle," however, is the most expensive of the privileges mentioned.

These contracts are favorites with small speculators who are willing to assume the risk the privilege costs for either a "call" or a "put" on a stock, in the expectation that the chance will occur during the life of their contract to execute it at a profit. However, such privileges ought to have the endorsement of a member of the stock exchange. They are good only if the maker of the contract is himself solvent.

Wash Sales

Wash Sales constitute one class of fictitious transactions which take place on exchanges. In wash sales two or more members get together to buy or sell stocks between themselves to establish quotations so that they may be reported in the official transactions of the stock exchange. These fictitious sales are forbidden by the rules of all regular exchanges and are not enforceable at law. Brokers who engage in such sales run the risk of detection and expulsion, which is to them a sentence of financial death.

Match Orders

Match orders differ from wash sales in that they are actual and enforceable contracts. One broker will have an order to buy one hundred shares or more at a certain price and another broker an order to sell a similar amount of stock at the same price, both orders emanating from the same source. These brokers without knowing that other brokers have countervailing orders from the same principal, execute their orders upon the floor of the exchange in the regular order. Such transactions cause an appearance of activity and a certain security which is unreal. The public unaware that these orders are artificial, accepts them as actual transactions.

Pyramiding

This denotes the operations by the use of paper profits made in transactions not yet closed and therefore not yet in hand. For instance, one may purchase one hundred shares of stock at 50 on a margin of 10 per cent of the paper value. If the stock advances to 60, the purchaser will then have 20 per cent margin, and he will purchase one hundred shares more. If the price then goes to 70, he will purchase 200 shares more, giving him 400 shares in all. If it next goes to 80, he will then purchase 400 shares more, giving him 800 shares in all, on which he has a margin of 10 per cent or $8,000. Up to this point his paper profits will be $7,000. If the market continues in its rise, he will continue accumulating stock until his account shows very large accumulated paper profits. If he then sells out, he will have turned his profits into cash, but if the market suddenly drops 10 points, he will not only have lost the profits on the last transaction, but will have lost everything. In other words, the inverted pyramid will have fallen and ruined him in the crash.

The use of paper profits in stock transactions as a margin for further commitments should be discouraged. The practice tends to produce more extreme fluctuations and more rapid wiping out of margins. If the stock brokers and banks would make it a rule to value securities for the purpose of margin or collateral not at the current price of the moment but at the average price of some months passed (provided that such average price were not higher than the price of the moment), the dangers of pyramiding would be largely prevented and the practice discouraged.

Arbitrage

The buying and selling of the same security in different markets, as New York and London or New York and Chicago, for the purpose of making a profit from the difference in quotation between the two markets, is known as arbitrage. This trading is, of course, based on temporary differences in prices between markets, due to some special cause, as against most other forms of speculation in which the risk is based chiefly on the time element. Transactions may be carried on profitably even on the variation of a slight fraction, but the business requires most scientific skill and rapidity of thought. The difference in time between London and New York, as well as local tendencies which have a remote bearing upon another market, tighter money, etc., account for the difference in prices. As between New York and London the business requires very quick conversion of London prices to American equivalents by means of tables prepared for this purpose. The expenses of communication for the transaction of the business, as well as of shipping the securities and securing insurance upon them, are expenses to be considered in determining whether the difference in price is sufficient to induce the broker to buy or sell.

Stock-Market Terms And Phrases. Test Questions

1. What is the distinction between a bull and a bear?

2. Distinguish between the longs and the shorts of the market. Illustrate.

3. What is meant by "ex dividend"?

4. What is the meaning of rights?

5. What is an Irish dividend?

6. Explain exactly what is meant by a call. A put.

7. What is meant by a spread? A straddle?

8. Explain what is meant by pyramiding.

9. What are wash orders ?

10. What is the meaning of arbitrage?