tion a clear distinction should be made between the two kinds of options.

In setting forth the economic importance of the puts and calls which we deal in in the securities markets, we wish to emphasize three major elements: First, their value for insurance against loss; second, their stabilizing quality; third, the opportunity afforded the operator to protect a position in the market at minimum risk.

The CHAIRMAN. You are a member of the New York Stock Exchange?

Mr. FILER. No, sir; a member of no exchange.

Mr. PECORA. You are in the put-and-call business?

Mr. FILER. Yes, sir.

A call is a negotiable contract giving the holder the right to purchase from the maker, for a specified length of time, a given number of shares of a certain stock, at a price fixed in the contract. The maker of the call agrees to deliver to the holder, at the holder's demand, a definite number of shares of a given stock at a stipulated price when the demand is made, before the expiration of the stipulated period of time.

A put is a negotiable contract giving the holder the privilege to deliver to the maker, for a specified length of time, a given number of shares of a particular stock, at a price stipulated in the contract. The maker of the put agrees to receive from the holder, at his demand, a fixed number of shares of a particular stock at a fixed price, if the demand is made before the expiration of the fixed period of time.

In appendix no. 1 will be found specimens of standard forms for put and call contracts employed by brokers and dealers in these

contracts.

We wish to make it clear that this presentation refers entirely to privileges-puts and calls-sold on a competitive basis at a fixed premium and publicly offered, as distinguished from so-called corporation or company options frequently privately offered in large blocks for manipulative purposes.

Possibly it would be in the interest of clarity if a brief historical summary of puts and calls were presented to the committee. These contracts have been developed and sanctioned by business practice over a period of 2 to 3 centuries. Undoubtedly, they had their origin in transactions involving the merchandising of commodities, and in this respect are closely akin to the future contract system now in vogue and such an indispensable part of the marketing of all great staple commodities. As a matter of fact, the future contract system was devised entirely for the purpose of insurance against injurious price changes. The put and call system is in the same category, for it insures the investor in securities against violent fluctuations due to unexpected developments.

In the business world options are used every day in one form or other.

An instance of the use of the option contract in a business that probably is familiar to every member of your committee is its protective use in real estate transactions.

A manufacturer wishes to extend his factory space, provided business conditions in the near future make this advisable. To do so he has to acquire a large parcel of real estate.

In order to insure that he can buy the property when he needs it, without committing himself definitely to the payment of a large sum of money for the same, he is perfectly willing to pay a relatively small sum of money to the owner of the land for an option or call for a certain period of time.

It is true that if he should not go through with his plans he will lose the cost of the option, but it is equally true that the amount which he paid for the insurance was very well worth while.

In connection with put and call contracts it might be pointed out that John Houghton, in 1694, described how puts and calls were used in connection with dealings on the London Stock Exchange. In 1816 the transactions in puts and calls already had reached considerable volume on the Berlin Stock Exchange. Today there is no important financial center where puts and calls are not dealt in and where they are not known as an important adjunct to security deal ings. At present, New York has developed into a large market for puts and calls, and financial interests all over the world are buyers of these contracts in New York.

Probably the most important function of puts and calls is the protection against unlimited loss they afford to the owner of stocks. The best method of illustrating the insurance feature of puts and calls would be to employ specific examples.

Let us take the case of United States Steel selling, say, at 55. An investor may have bought the stock at 53. He feels reasonably confident that his judgment has been sound, but he wishes to guard against any unforeseen contingencies. He consequently pays $137.50 for a put, this charge being in the nature of an insurance premium. The put price is 51. If, during the 30-day period, the market should decline and Steel, let us say, sells at 45 at the end of the 30-day period, he will deliver 100 shares to the writer of the put at 51. In other words, while the best price he can obtain on the stock exchange is 45, he has been able to dispose of his stock at 51 through the medium of the protection of his put contract.

An investor holds 100 shares of Steel at 53. He buys a call at 57 good for 30 days feeling that if he should sell his long stock, he can by reason of his call contract, recapture the stock at 57, if it is to his advantage to do so.

Thus far this memorandum has referred entirely to the buyer of these contracts. It should be interesting to describe the position of the seller of these contracts.

The maker of the put in the case of Steel, selling at 55, is willing to accumulate the stock at 51, if it should decline. In the event that the stock is put to him by reason of the premium of $137.50, less the commission charge, which he has received, the cost to him is reduced to that extent. In case the put is not exercised, the maker of the contract has received substantial compensation for the insurance contract.

As the seller of the call usually is the owner of stock, he is perfectly willing to sell the amount of shares represented by the call contract at the advance plus the premium he received.

It can be seen that in both the cases of the buyer of the put or call and the maker of these contracts that there may be in the majority of cases a mutual advantage.

In the opening paragraph reference is made to the stabilizing influence of the put-and-call contracts. The owner of a stock without put protection in a market that is unsettled and weak in many cases would be inclined to liquidate his holdings and add to the pressure on the market. With his courage fortified by the put he is completely immune from the panic psychology that besets other holders not similarly protected. The reverse would be the case in a boiling bull market when an investor who had previously disposed of his stock might be inclined to rebuy at an inflated price but is restrained from such impetuous action by owning a call which enables him to participate in the rise.

It is not the purpose of this memorandum to contend that puts and calls are free from speculative possibilities. The individual who buys the call pays a premium for the privilege of participating in the rise in the stock above the call limit, without actually owning stock. In the case of a strong, rising market, he may be able to reap a considerable profit before the expiration of the 30-day contract call period.

The buyer of a put may not be long of a stock and may wish to participate in any profits resulting from a sharp decline. Please bear in mind that this individual is not a short seller and that when he buys his stock against his put he is fully protected from loss and thus becomes a supporter of a falling market.

In the earlier part of this memorandum reference was made to the similarity between the put and call contracts in securities and the hedging operations in the case of commodities. Essentially they are the same. Numerous legislative decisions have sanctioned their validity, but it seems undesirable to take up the time of the committee by reciting these in detail. A typical instance should suffice, and the occasion is taken to cite the case of the Board of Trade v. Christie Co. (198 U.S. 236). In delivering his opinion Mr. Justice Holmes, of the Supreme Court of the United States, said:

Purchases made with the understanding that the contract will be settled by paying the difference between the contract and the market price at a certain time stand on different ground from purchases made merely with the expectation that they will be satisfied by set-off * * *. Hedging * * is a means by which collectors and exporters of grain or other products and manufacturers who make contracts for the sale of goods secure themselves against the fluctuations of the market by counter contracts for the purchase or sale, as the case may be, of an equal quantity of the product or of the material of manufacture. It is none the less a serious business contract for a legitimate and useful purpose that it may be offset before the time of delivery in case delivery should not be needed or desired.

The foregoing completes our presentation of the modus operandi and merits of the put-and-call operations on the various security exchanges, except to mention that the United States Government derives a substantial income from the tax on call contracts under the 1932 Revenue Act.

Before we conclude we wish to emphasize to the utmost the sharp distinction between the two kinds of put-and-call contracts. The class we sponsor is competitively sold, openly offered for a stipulated sum, guaranteed by stock-exchange firms, and protected by margins as in the case of purchase and sale of stocks. These contracts have no kinship with options privately or secretly issued by individuals, groups, corporations, or companies who, seeing speculative opportu

nities in a particular security, offer these options for manipulative purposes, usually in conjunction with pool operations. It is our understanding that such operations recently have come under the ban of the New York Stock Exchange.

We trust your committee will recognize the economic relation of these put-and-call contracts to the security markets not only of the United States but the entire world. In fact, the London Stock Exchange, the oldest institution of this kind, places only one restriction upon these transactions, namely, that they are not permitted to run over a period exceeding approximately 105 days.

We are firmly convinced that these contracts serve the useful purposes of providing insurance, of stabilizing the market, and limiting losses to the public.

In conclusion, may we respectfully call the attention of the committee to the fact that every form of property can be insured against partial or total loss, whereas put and call contracts furnish the only known form of insurance against unlimited loss in securities.

The CHAIRMAN. What is your responsibility to the holder? Suppose for one reason or another you are unable to carry out the contract. Are you liable in any way?

Mr. FILER. No, sir; and it says so on the face of the contract. The CHAIRMAN. You are simply agent?

Mr. FILER. Yes, sir; but if I buy a man a contract I will deliver it to him.

In the appendix, too, Mr. Chairman, are some various court decisions. If they will go in the record I would rather not bother to read them.

The CHAIRMAN. Yes; that is not necessary. They may be incorporated in the record.

(The matter submitted by Mr. Filer as an appendix to his statement will be found in the printed record at the end of today's proceedings.)

The CHAIRMAN. Are there any questions?

Senator KEAN. I would like to ask some questions. That is something I do not know much about, but I would like to ask you, is it not true that there is a tremendous business in puts and calls in London? That is true, isn't it?

Mr. FILER. Yes, sir.

Senator KEAN. And that a large part of the speculation in stocks in London is carried on by put and call?

Mr. FILER. So I have read.

The CHAIRMAN. In the case of puts and calls the parties do not own the stock at all; they just put up the difference, do they? There is no stock passed?

Mr. FILER. Oh, there is stock passed, absolutely.

Mr. PECORA. That is where the option is exercised?

Mr. FILER. That is where the option is exercised. It is my impression that in drawing up this bill these two classes of options were not recognized as being so totally different.

Mr. PECORA. Would you say, broadly speaking, a put or call is an option for a price and given at a price? That is, one pays for the option?

Mr. FILER. In buying or selling stock at a price.

Mr. PECORA. Yes.

Mr. FILER. Within a period of time.

Mr. PECORA. One pays for the option to buy and sell the stock at a price in the option?

Mr. FILER. That is right, within a period of time.

Mr. PECORA. Are there any statistics available to which you could refer us showing what proportion of cases puts and calls are exercised by the holders?

Mr. FILER. Well, of course, it is according to the activity of the market.

Mr. PECORA. Are there any figures or statistics available on that? Mr. FILER. No. I could just say this, Mr. Pecora : I have been in the business about 15 years, and if you want to take my estimate I will be glad to give it.

Mr. PECORA. What would it be?

Mr. FILER. I would say that about 122 percent of the options that are written are exercised. But because they are not exercised does not say they do not serve a valuable purpose in the meantime.

Mr. PECORA. I merely wanted to get whatever figures were available, and now you have given us some idea based upon your own personal business.

Mr. FILER. That is right.

Mr. PECORA. In dealing in puts and calls. You say that about one eighth of them are exercised?

Mr. FILER. About 122 percent are actually exercised at expiration time. That is over a period of time in a normal market.

Mr. PECORA. Yes, sír; and the other seven eights, the persons who buy these puts and calls, do not exercise them, and what they have paid for them is lost to them?

Mr. FILER. It is not lost. It is similar to an insurance premium that a man pays for

Mr. PECORA. Yes. I mean they do not get it back; they pay that for an option to buy or to sell the stock at a fixed price?

Mr. FILER. It is not lost. It is not a case of not getting it back. They may have received that insurance. It may be that because a man holding a put through a falling market does not sell his stock out at a loss, and before the 30 days are over can sell that stock out at a profit. Now, he may not exercise the option, but the option has served a very valuable purpose.

Mr. PECORA. It has served a potential purpose.

Mr. FILER. Served a real purpose.

Mr. PECORA. In other words, it gave him a certain amount of what you call insurance.

Mr. FILER. Actual insurance.

Mr. PECORA. Actual insurance. But if he does not exercise his option under the put or call, why, what he has paid, let us say by premiums, by way of that insurance, he is out of pocket?

Mr. FILER. He is out of pocket. I would not call it a loss, any more than I would call a loss when I pay a premium on fire insurance and my house does not burn down.

Mr. PECORA. You say, based upon your experience in this business that about seven eighths of the options are not exercised? Mr. FILER. That is right.