Tigers in the Pit: The Pacific Exchange 2003

Tigers In The Pit

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“I remember my first day trading, it was very

people who had established themselves in th

knew who was boss in that crowd. A great tr

pit that I ever traded in. After my first day tra

for me, he came up to me and rattled off, in s

that day. I didn’t remember more than one o

y common to intimidate new traders. The

he pits wanted to make sure that everyone

rader by the name of Jeff Eng was in the first

ading, which was a huge, very stressful day

succession, every single trade I had done

or two trades.”

C, Lead Market Maker

“The Pacific has historically been the most innovative exchange in the country. We have been the source of innovation that has fundamentally changed the way stocks and options are traded in this country.

In 1956 the end of every trading day, in San Francisco, Los Angeles, New York and every other city that had an exchange, you had couriers running up and down Montgomery St. [SF] with satchels, one full of cash or checks and one full of stock certificates. Every trade for that day was cleared and settled with the physical delivery of assets; cash and checks from buyers to sellers, the physical stock certificates from sellers to buyers.

The Pacific thought that was kind of crazy so they developed net-by-net clearing… It wasn’t until 1973, ’74, or ’75 I guess, that the New York Stock Exchange adopted the net clearing and settlement we had been using for 20 years…

[In] 1969 we became the first exchange in the world to put a computer on the trading floor. It changed the market completely.

Every electronic system that has developed since 1969 is a next generation of the original system the Pacific built, every single one of them.

It’s changed the way people trade, it’s changed it tremendously. Speed is everything.

15 seconds, which is the original length of time it took to get an order done on the Pacific, 15 seconds is an eternity in this market. People offer 3 second guarantees and that’s an eternity. It’s amazing.

We have been innovative because of the culture of California. People come here, people come because they want to live differently. Think differently.

Work differently. They’re willing to come here with the intention of breaking sharply with the conventional.”

C, Pacific Exchange

Done during 2003 in San Francisco, documents the trading floor of the Pacific Exchange which had moved from its majestic old building at 301 Pine to the Mills Building, a few blocks away.

Change was coming. The trading floor, domain of the “Tigers of the Pit”, was becoming obsolete, a fare cry from the heady days of “roaring 90’s)

“In the heyday it was such its own world. In those days, people did go out after the market closed to the bars. And there was drug use and partying, but the traders were in their 20’s.

As they grew up, many left the business, started families. That culture changed. It used to be [you’d be] able to go over to the Sutter Gutter at 1:15 PM and find about fifty to sixty traders already going at it.

[There were] flights to Vegas over the weekend and [they would] pay for the book staff to go with them. Those days are gone.

You know, people, they’re just older; they don’t have that sort of recovery, I guess…

I think that when that was the case, it was at their detriment.

You were hanging out with people who did the same thing, who had the same stress levels, who wanted to blow off steam in the

exact same way.

It was a competition during the day, trading. It was a competition of who could make the most money. It was a competition of who could drink the most at night. Or do the most coke and then come back the next day…

There doesn’t seem to be that sort of atmosphere anymore where people are coming in without having slept all night, or strung out and ready to lose it. I mean I’ve seen people come in so drunk they actually had to be escorted off the floor.

You don’t see that anymore.

But I really think that’s more of a function of people growing up. Instead of people 24, now they’re 40, which is scary if you think of the markets that were being made in derivatives.

I don’t know how people on the outside world picture market makers but, I can tell you, before I was one I certainly held them in high esteem, thinking these

must be brilliant people. Now I know they’re typically bright people, but they were once just 24 year-old partiers as well.”

C, Lead Market Maker “The rules that we use down on the floor are so outdated. As the times have changed, the rules have not. I actually had a long conversation with Surveillance today. [They were] explaining to me that in 1976 we came up with these ideas to keep these options open. Maybe back then it was OK because the margins were wide, but now it’s at our expense.”

G, Market Maker “All the problems the New York Stock Exchange is having right now, that will accelerate the migration to an electronic environment because the structure of the electronic market is different.

On the floor of an exchange you have specialists. You have certain people who are allocated

the right to make markets in certain stocks.

In most cases they are granted the exclusive right to make markets in those stocks so they have an opportunity to capture monopoly profits… They’re the only ones that have access to The Book, to see all the buy and sell orders that customers have entered to buy and sell away from current market prices. That’s extremely valuable information because it can give you a sense of where the market is going in the short term.

The specialists have the ability to step in front of public orders and buy and sell for their own account. They do that in anticipation of the market going one way or the other.”

C, Pacific Exchange

“… you’re going to get a different price if you have a thousand shares to buy verses a hundred thousand shares to buy. So even though it may seem like you’re going to the market place and you see the price you should be able to get, you’re not guaranteed that price… The larger the trade the larger the risk so it justifies a higher premium, or a lower premium if they’re selling them to the market makers… Supply and demand, obviously, is one of the main factors that traders use to decide what’s the appropriate price. But there are other factors as well. A ten-lot can move a market significantly in an issue if they perceive that on the other side of that trade

is a smart trader. A smart paper as they call it, not your grandma from Kansas sending in an order, but a very intelligent, savvy trader. That tenlot is going to have a different meaning if they know it’s coming from a so called smart trader [rather] than a regular retail customer who they don’t think knows a lot.”

C, Lead Market Maker “To be honest, it’s very difficult when you’re trading as many issues as most people trade on the floor right now.

It’s almost like you’re just putting out fires. You pick those positions, those stocks that are most active, have the most potential to hurt you.”

C, Lead Market Maker

“I’m a firm believer [that] we will not be down here on the floor within probably 2 to 3 years. The people that don’t believe it are not going to easily be players in the new market.”

C, Lead Market Maker “I trade a lot more now for less edge than I ever did before.

My notion of risk has changed.

Granted I’ve developed as a trader, but now I take an immense amount of risk for significantly less reward. To try and do better than you did before, you have to take an exponentially higher amount of risk to try and beat what you used to make. The flip side is, if you have something on the wrong way, it’s a lot easier to get out of it now than it ever used to be.”

G, Market Maker “I remember when some very, very intelligent traders came down onto the floor to become Market Makers. Their resumes

were PhDs., scientific backgrounds, math majors. You thought, wow, trading derivatives is going to be great for them because they’re so brilliant. But they stood in the back of the crowd and they never got in on a single trade.

[They] were out of business within a couple of months. They just couldn’t compete with the tigers in the pit.

The ones that were more the athletic type, competitive, you knew they just had that in their blood… There’s nowhere to get educated on how to trade on a trading floor other than on a trading floor. You can’t go to college and get a degree and come in prepared to go into a pit. It takes awhile to learn the language, to learn the dynamics. And that education takes place on the floor and nowhere else…

You know some of the most successful traders on this floor

barely had a high school diploma. They were world-class bridge players or chess players, backgammon players, poker players, who got into this business. That probably won’t happen anymore.

The people that will be hired in this business as the dominant firms take over will be the same people that have always been hired by these firms (the Morgan Stanleys, the Goldwyn Sachs of the world). They’ll be the MBA and investment banker types. No longer if you have [only] a high school education but you’re a fantastic mind and thinker, will you get a shot.

Those days too are over.”

C, Lead Market Maker “We have such a contentious relationship as market makers with the brokerage firms on the floor because they’re fighting for their customers and we’re fighting for profitability against their customers, so the battle wages on. It

seems like the majority of the disagreements that come about in a day, it’s market maker verses broker. It’s funny because they’re the hand that feeds us, they’re the ones that bring us the business.

At the same time, they’re the ones that shop orders upstairs to get their customers a piece of the action [and] they’re the ones that need help out of errors that cost us money.”

C, Lead Market Maker “[In] our pit you really have to know what you’re doing. A lot of these guys on the floor really don’t know what they’re doing.

The old-school guys, most of them are gone or not doing well because their heyday was when markets were maybe a whole dollar wide, a dollar and half wide. For them there was tremendous room for error. Now there’s no more room for error.”

G, Market Maker

“When I got into the business, I got into the futures side and I started at the Chicago Mercantile Exchange in the Euro Dollars. [I] worked there as a clerk and then [in] the 30-year bond options pit.

That is like the ultimate open out cry; futures trading, futures options and futures pits. When I started trading, I started in the corn options. That’s like without these computer screens, so there’s no disseminated bid and offer. Everything is quoted through brokers, so there’s less transparency into the market place… The screens are ultimately our enemy… The screens facilitate liquidity very well. Actually [that’s] not a good thing if you’re there to create liquidity in an ill-liquid market where those who want to trade need to look to you for a bid and offer. That’s kind of how you want to keep it.

That’s the reason the New York Stock Exchange is in so much trouble because they have had their specialists keeping the out-

side players from looking in.”

G, Market Maker “When I came on the floor nine years ago, Casey Securities, which is the largest brokerage firm on the Pacific Exchange, probably had 20-30 runners because that is, of course, how they delivered the tickets into the crowds in those days. Everything is done by computer now.

It’s electronically routed via the broker handhelds; runners don’t exist. I don’t even have clerks for my firm. I used to, in the heyday, have 24 traders and about 10 clerks. I’m down to about 14 traders with zero clerks.”

C, Lead Market Maker “In 1976 [you] could be a market maker if you had 5 or 10,000 dollars in capital, not very much.

Today 150,000 dollars minimum and you’re going to be standing on the floor with firms that have billions available to them.

It’s a much different market. 5

calls, 10 puts, that was the common trade in the early days.

Now you have institutions and they want to do 10,000. And as soon as they’ve done it, they want to do another 10,000. Institutions want to do all kinds of spreads and combinations that involve three different puts and three different calls. Different strike prices, different expiration dates. They don’t care what the individual options cost, they want the package at X. It takes a lot more capital to play in that game than it did back when you were doing 5 puts and 10 calls at a time.”

C, Pacific Exchange “The new marketplace provides for those firms who are large, well capitalized, and highly technological, a clear advantage over those traders who made their living standing in a pit, experiencing success because of their aggressiveness and pit presence.

All the skills that you learn in

the dynamics of a trading crowd don’t have any bearing on your success behind a terminal.”

C, Lead Market Maker “Market making, it’s tough. The trend is your friend and the trend is moving away from market making.”

G, Market Maker “It’s probably more important to understand game theory than economics. I would argue that game theory is probably a little more difficult to understand than economics. There are some firms that do very well in the derivatives business, that encourage, if not force, their employees to study, understand and know game theory. And [to] be excellent poker players. Those skills are directly transferable to trading.”

C, Lead Market Maker

“… when options first started trading years ago, the normal bid-ask spread for an option was 40 cents. Now those same spreads are a nickel wide so you have to trade more and more volume in order to make profit and you take on more and more risk as you accumulate more contracts in your position.

Those small players could make a good living trading very small because of the wide bid-ask spreads. Now that more participants have gotten into the marketplace, those spreads have narrowed and competition has increased drastically with the five exchanges that now make markets, and other exchanges looking to enter into this business. It will definitely squeeze, and has already squeezed, a majority of the local small traders out of the business.”

C, Lead Market Maker

“Not much has changed on the floor as far as its makeup. I look at these screens and how the persons behind the book are still executing orders manually, [and] one of the things we see happening is the traders off of the floor, that have electronic access, are beating the traders who stand on the floor. [They] are beating them to trades because they have electronic access to the markets but the market maker standing in the crowd still has to verbally initiate an execution.

They have to do that with another human being. So in a conversation about buy-the-book March 40 calls, within that time, before another human being can actually do the manual execution necessary, here comes a electronic order off the floor and scoops that trade, in front of the members who are paying dues to have first shot at that trade.”

C, Lead Market Maker

“With technology everyone can see the market. Everyone who is now off the floor can see the sizes and the speed. So we’re actually almost at a disadvantage for being on the floor when we’re competing against an electronic competitor. The only advantage to being on the floor right now is that there are still customers who enjoy talking to a human being, and who want to send their orders via phone.”

C, Lead Market Maker “… trading floors are enormously expensive and they are very much a fixed cost operation.

The space is dedicated. The equipment is dedicated. The screens are dedicated. The lines are dedicated. You have to eat that cost regardless of how active the market is. So when the market slows down, exchange revenues drop. When the market is very active, exchange rev-

enues go up. It doesn’t matter if the market is up or down, as long as the market is active the exchanges make money. When you move to an electronic environment your fixed costs go way, way down… I think every U.S. exchange is going to move to a completely electronic environment in a relatively short period of time. None of the new exchanges that are opening anywhere in the world are opening trading floors.”

C, Pacific Exchange

“Used to be that you called your broker and said I want to buy 100 shares of Wells Fargo, he would say OK, I’ll call you back.

He would write up a little slip of paper, put it in a cylinder and stick it in a pneumatic tube.

That little car would run off through the walls and ceiling of the firm and it would end up on the firm’s trading desk where a guy would open up the cylinder and unroll the paper and say I’m going to send this order to the PCoast and he would call a floor broker and the equities floor in San Francisco or LA and give the floor broker the order. The floor broker would say I’ll call you back, write up a slip of paper, carry it over to the specialist who traded Wells Fargo and… they would agree on a price.

The floor broker would go back to his desk and he’d write up a report. He’d call the trading

desk of the firm and give them a report, you bought 100 shares of Wells at X, thanks very much.

The clerk on the trading desk of the firm would write up a report, a copy would go back into the cylinder, back into the pneumatic tube, back through the bowls of the firm and show up on the broker’s desk. He would call his customer and say you’re filled.

Sometimes the confirmation call didn’t come until the following day.

[Then in] 1969 we roll out a system that gives brokerage firms the ability to route orders to us electronically. Now the customer calls and says I want to buy 100 shares of Wells. The broker says hang a second, reaches across his desk, a few keystrokes on a keyboard, the order bypasses the firm’s trading desk, bypasses the floor broker, it goes straight to the specialist that trades

Wells, shows up as two lines on a screen in front of him.

This firm is sending you a hundred shares of Wells to buy at the market and this is the price I, the system, am going to assign to this trade, Mr. Specialist, if you doing nothing in the next 10 seconds. And there was a little clock at the end of that line that would count down, 10, 9, 8, 7, …psh and the order would be gone.

It would be electronically reported to the ticker tape, back to the broker completed at this price.

So the broker, still on the phone to his customer says, you’re filled. The whole process took less than 15 seconds.

That was 1969. …the first day they brought up the system, down in Los Angeles one of the specialists brought in a pair of hedge clippers, you know big

garden shears. “No goddam machine is going to be trading my position”, and he cut the wires going to the back of the computer.”

C, Pacific Exchange A trader misheard me and we have an out-trade on price. He thinks he paid one-eighty; I think I sold them at one-eight-five. In futures options this stuff is usually split between the broker and the trader. On this exchange and on most stock options floors, the broker is the one holding the cards. The broker usually gets let out of out-trades unless it’s an untimely complaint. But if it’s close to the market quote of ten the broker just gets let out of the out-trade.”

G, Market Maker “When I think about how archaic some of our technology is..., the Exchange is not putting any more money into the infrastruc-

ture of the floor.

If you had come on to the Exchange even two years ago you would have seen about 500 traders filling most every pit on the floor…

It’s very easy to walk across the floor now. There’s probably about 220 traders on the floor and the noise level even though it’s a very volatile market time isn’t what is was.

I mean it does get load, but nothing like the crescendo of the earlier days. It was deafening. You could not hear anything when the market would make a significant move.

I recall back in 1997 when they had the “Asian Contagion”, the market actually had to be halted with an hour left to go in the trading day because the DOW had slid so many points. It went from a day of super volatility, and deafening noise to total quiet the moment they rang the bell early, which is the only time I’ve ever experienced that.

People filed out so uniformly and quiet, you could hear a pin drop. It was an eerie feeling to go from the loud deafening noise to a bell having to be rung an hour early and then traders just silently filing off.

No talking. I’ll never forget that day.”

C, Lead Market Maker “If you look around the floor today you’ll see that people have grown up, myself included. We’ve aged and you don’t see the new younger faces coming into the business anymore.”

C, Lead Market Maker

“What these guys are doing is they’re on the phone with the customers and the broker dealers. Broker dealers are guys that trade upstairs and try and get in on customer orders by what they say is shopping the order. With due diligence these brokers are supposed to come into the crowd, quote what they’re interested in trading, give the customer the quote, and if the customer has a limit on his order that he wants to get filled at a certain price, then the brokerage firm is supposed to disclose what the order is.

[For instance], “I have thousand of eighty calls at a dollar eightfive.” We say we’re one-seventy-five bid at one-ninety. He’s at one-eighty-five. If the stock goes up these become more attractive, so he might say, I’m shopping the order. This how he’s supposed to do it. Then he can call all his buddies in New York and Chicago and try

and find another customer who wants to buy these things, or a broker dealer who wants to buy them. It’s in his best interest, not the customer’s he’s representing best interest but in his best interest, to find someone who will take the other side of this trade. [Because]... say he charges the customer a dollar per contract, he might also charge the broker dealer a dollar if he, the trader upstairs, he can take both sides of this order. If the broker dealer [trader upstairs] wants to buy these from the customer, then the floor broker gets to buy his own offer representing the upstairs trader on the buy side and representing his customer, who originally gave him the order, on the sell side. We call that double billing. So that’s the way it’s supposed to go down. But what some do more than others [is] they immediately, when they get the order, get on the

phone and try shop the order as they’re bringing it into the pit. If it’s a market order they’re likely to really try and shop it because if they can improve our bid, if they find a broker dealer or trader upstairs who can improve our bid, then he has a better chance of crossing the order.

Market orders should be executed immediately but maybe they have a booth in New York… and in New York they say what can I cross? And we’ll say, you can cross 30%. He’ll say New York wants to give us 40%. We’ll say, why is this order here? We have a conflict because we’d rather trade it here than see it go to New York because, if there’s edge in this trade, I’m not in New York, I’m here. I’d like to see the trade go up here so they have leverage. Meanwhile it’s a market order. Say the market is going down… while he was trying to find someone to take the other side of this order, the

market is selling off. Because of that we adjust our value, our theoretical value goes down… we’re fading it to the buy side because the market’s selling off.

Now because he was trying to shop the order so he can get on both sides of the ticket, he’s already cost his customer a nickel or more (the theoretical value of the decline). That’s common practice.”

G, market maker “When I started trading, I think I traded three stocks. I may have traded a hundred contracts my first day. Now I trade over sixty stocks, trading almost twenty thousand contracts a day. The amount of business one person can handle because of all the advances in technology, it’s incredible. You need fewer and fewer people.”

C, Lead Market Maker

“Years ago, there were never chairs allowed on the floor. You stood all day and you stood typically pretty early before the market opened because there was such fierce competition for business that there were literally market makers coming in at 3 o’clock in the morning, and the market doesn’t open ‘till 6:30, to get a spot; a particular spot, usually next to a certain broker that had good paper.”

C, Lead Market Maker “The automation. We used to use what we call Delta sheets, theoretical sheets that would printout in the morning. With these sheets we had all sorts of different scenarios of stock

movement. For each snapshot of stock price we would adjust the theoretical values of all these different series and chains of options. Now we have the hand held. You can alter all sorts of aspects of our theoretical values with just the clicking.

That’s allowed us to manipulate option values in a more dynamic way during the day. You can synthesize your position, meaning for each stock all your options [are] put together into a series of common denominators that represent exposure to changes in volatility (Vega), changes in the stock price (Delta) and Gamma (the second derivative of Delta).”

G, Market Maker

“Those people that say this floor will be around a lot longer than 2 or 3 years are probably those people that give a lot of credence to the bonds and relationships that brokerage firms have established with clients over the long haul.”

C, Lead Market Maker

“If they close the doors to this place it won’t matter to me. I’m planning on taking a time out anyway, just to take a breather. It takes forever to get out of these options positions, literally [you] have to look months in advance.”

G, Market Maker

“I think if you can make ten years, that’s about as much as a person can take. You see a lot of people work about that much, and then take some time off, then come back to the field refreshed. There are some people [for] whom the stress and just worrying overnight about positions takes too much of a toll and they don’t make it past the first couple of three years. But then there are those ... there’s a gentleman in our crowd whose ability to stay in this business is nothing short of amazing, being one of the first traders down here on the floor and still being down here today. That’s an accomplishment; a span of thirty years is incredible.”

C, Lead Market Maker

“I feel really lucky to have been a part of it for the years I was here.

But at the same time, it is a toll.

It takes a toll on your body in the stress and a lot of these people, I think they’ll adapt [to the move to an electronic platform] somehow or another and be happy that they don’t spend their days down on the floor anymore. It’s a hard place to be sometimes.”

C, Lead Market Maker

“Our objective is to be able to operate independent of the floor by the end of 2006. Doesn’t mean necessarily an end to the floor, as long as people want to be down there and they’re willing to pay for it, we’ll keep it open.”

C, Pacific Exchange “Public confidence is so central to what we do as a business. [If] we lose that public confidence, people don’t trade and you lose your business. If people are not willing to buy and sell stocks, they’re not willing to invest capital, the economy doesn’t grow, jobs don’t get created.”

C, Pacific Exchange

“There will always be a role for an exchange. Even as we move away from trading floors to an electronic environment, the three fundamental purposes of an exchange don’t change.

Somebody still has to build and maintain these systems. Somebody still has to find companies to list and options to trade. And somebody still has to regulate the market place.”

C, Pacific Exchange

In 2003 the San Francisco Options floor was the only physical trading pit left on the West Coast, the place Market Makers stood shoulder to shoulder making deals the old physical way.

In October of 2003 the PCX started using a system that allowed traders to buy and sell options without physically being on the floor. By December of 2004 every option available on the floor became available on the new system.

The end was near for the “Tigers of the Pit”.

The switch from a physical trading floor to an electronic one meant traders on the Pacific Exchange could be anyplace in the world. Volume increased from 15 to 25 million shares a day in 2001, to 650 million shares in early 2005. The number of traders went from 75 on two floors, to 700 on the electronic “floor”.

In 2005 the Pacific Exchange was sold to Archipelago and ceased to exist as a separate entity. Within a year Archipelago merged with the NYSE.

EQUITY TRADING TERMS

er stock of the corporation.

AT THE MARKET: Describes an order to purchase or sell securities at the best price currently available.

DAY ORDERS: Orders to buy or sell that expire if not executed on the same day entered.

BEARS: Those who believe stock prices will decline. A bear market is one in which prices trend downward.

BID and OFFER (ASK), also called the QUOTE: The bid is the highest price a buyer will pay for a security; the offer is the lowest price at which a security is offered by sellers.

BLOCKS: Large holdings or stock transactions, usually 10,000 shares or more.

BULLS: Those who believe the market will rise. A bull market is rising.

COMMON STOCK: A security representing ownership interest in a corporation, carrying the right to dividends subordinate to all oth-

FLOOR BROKERS: Exchange members who execute buy and sell orders on the floor for customers.

LIMIT ORDERS: Orders to buy or sell a stated amount of a security at a specific price or, if obtainable, a better price.

LOCAL LISTING: A “local” listing is one where the company is neither seeking, nor has already obtained, a listing on the NYSE or the AMEX. ODD LOTS: Amounts of stock less than the established unit of trading, usually 100 shares.

OPEN (GTC) ORDER: A standing order to buy or sell, valid until either canceled or executed. GTC orders usually expire within six months, depending upon the

brokerage’s policy. GTC means “Good Till Canceled.”

PRIMARY MARKETS: The primary exchange on which a listed stock trades.

ROUND LOTS: Units of trading, usually 100 shares.

SEATS: Traditional description of memberships on an exchange.

STOPS: Orders instructing brokers to buy or sell at the market if and when a stock’s price rises or falls to a certain price.

TICK: Direction the price of a stock moved on its last sale.

An up-tick means the last trade was at a higher price than the one before it, and a down-tick means the last sale price was lower than the one before it. A zero-plus tick means the transaction was at the same price as the one before, but higher than the nearest preceding different price.

TICKERS: Electronic display of the prices and volumes of stock trades worldwide, usually updated within 90 seconds after each transaction.

OPTIONS TRADING TERMS AMERICAN-STYLE OPTION: An option contract that may be exercised at any time between the date of purchase and the expiration date. Most exchange-traded options are American-style.

ASSIGNMENT: The receipt of an exercise notice by an option writer (seller) that obligates him to sell (in the case of a call) or purchase (in the case of a put) the underlying security at the specified strike price.

AT-THE-MONEY: An option is atthe-money if the strike price of the option is equal to the market price of the underlying security.

CALL: An option contract that gives the holder the right to buy the underlying security at a specified price for a certain,

fixed period of time.

tion in a given series of options.

CAPPED-STYLE OPTION: A capped option is an option with an established profit cap or cap price. The cap price is equal to the option’s strike price plus a cap interval for a call option or the strike price minus a cap interval for a put option. A capped option is automatically exercised when the underlying security closes at or above (for a call) or at or below (for a put) the option’s cap price.

COVERED CALL OPTION WRITING: A strategy in which one sells call options while simultaneously owning an equivalent position in the underlying security.

CLASS OF OPTIONS: Option contracts of the same type (call or put) and style (American, European or Capped) that cover the same underlying security.

CLOSING PURCHASE: A transaction in which the purchaser’s intention is to reduce or eliminate a short position in a given series of options.

CLOSING SALE: A transaction in which the seller’s intention is to reduce or eliminate a long posi-

COVERED PUT OPTION WRITING: A strategy in which one sells put options and simultaneously is short an equivalent position in the underlying security.

DERIVATIVE SECURITY: A financial security whose value is determined in part from the value and characteristics of another security, the underlying security.

EQUITY OPTIONS: Options on shares of an individual common stock.

EUROPEAN-STYLE OPTION: An option contract that may be exercised only during a specified period of time just prior to its expiration.

EXERCISE: To implement the

right under which the holder of an option is entitled to buy (in the case of a call) or sell (in the case of a put) the underlying security.

EXERCISE PRICE: See Strike price.

EXERCISE SETTLEMENT AMOUNT: The difference between the exercise price of the option and the exercise settlement value of the index on the day an exercise notice is tendered, multiplied by the index multiplier.

EXPIRATION CYCLE: An expiration cycle relates to the dates on which options on a particular underlying security expire. A given option, other than LEAPS, will be assigned to one of three cycles, the January cycle, the February cycle or the March cycle (See Appendix). At any point in time, an option will have contracts with four expiration dates outstanding, the two near-term months and two further-term

months.

EXPIRATION DATE: The day in which an option contract becomes void. All holders of options must indicate their desire to exercise, if they wish to do so, by this date.

EXPIRATION TIME: The time of day by which all exercise notices must be received on the expiration date.

HEDGE: A conservative strategy used to limit investment loss by effecting a transaction which offsets an existing position.

HOLDER: The purchaser of an option.

IN-THE-MONEY: A call option is in-the-money if the strike price is less than the market price of the underlying security. A put option is in-the-money if the strike price is greater than the market price of the underlying security.

INTRINSIC VALUE: The amount

by which an option is in-themoney.

LEAPS: Long-term Equity AnticiPation Securities, or LEAPS, are long-term stock or index options. LEAPS, like all options, are available in two types, calls and puts, with expiration dates up to three years in the future.

LONG POSITION: A position wherein an investor’s interest in a particular series of options is as a net holder (i.e., the number of contracts bought exceeds the number of contracts sold).

MARGIN REQUIREMENT (for options): The amount an uncovered (naked) option writer is required to deposit and maintain to cover a position. The margin requirement is calculated daily.

NAKED WRITER: See Uncovered call writing and Uncovered put writing.

OPENING PURCHASE: A transaction in which the purchaser’s in-

tention is to create or increase a long position in a given series of options.

OPENING SALE: A transaction in which the seller’s intention is to create or increase a short position in a given series of options.

OPEN INTEREST: The number of outstanding option contracts in the exchange market or in a particular class or series.

OUT-OF-THE-MONEY: A call option is out-of-the-money if the strike price is greater than the market price of the underlying security. A put option is out-ofthe-money if the strike price is less than the market price of the underlying security.

PREMIUM: The price of an option contract, determined in the competitive marketplace, which the buyer of the option pays to the option writer for the rights conveyed by the option contract.

PUT: An option contract that

gives the holder the right to sell the underlying security at a specified price for a certain fixed period of time.

SECONDARY MARKET: A market that provides for the purchase or sale of previously sold or bought options through closing transactions.

SERIES: All option contracts of the same class that also have the same unit of trade, expiration date and strike price.

SHORT POSITION: A position wherein a person’s interest in a particular series of options is as a net writer (i.e., the number of contracts sold exceeds the number of contracts bought).

STRIKE PRICE: The stated price per share for which the underlying security may be purchased (in the case of a call) or sold (in the case of a put) by the option holder upon exercise of the option contract.

TIME VALUE: The portion of the option premium that is attributable to the amount of time remaining until the expiration of the option contract. Time value is whatever value the option has in addition to its intrinsic value.

TYPE: The classification of an option contract as either a put or a call.

UNCOVERED CALL OPTION WRITING: A short call option position in which the writer does not own an equivalent position in the underlying security represented by his option contracts.

UNCOVERED PUT OPTION WRITING: A short put option position in which the writer does not have a corresponding short position in the underlying security or has not deposited, in a cash account, cash or cash equivalents equal to the exercise value of the put.

UNDERLYING SECURITY: The security subject to being purchased or sold upon exercise of the option contract.

VOLATILITY: A measure of the fluctuation in the market price of the underlying security. Mathematically, volatility is the annualized standard deviation of returns.

WRITER: The seller of an option contract.

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