Want to Bet on the Dow? You Now Have Options
The world’s largest futures exchange and its smaller sister exchange begin trading futures and options for the Dow Jones industrial average today in one of the most expensive launches ever.
The Dow average is the best known index of U.S. stocks, tracking 30 of the biggest U.S. companies, including General Motors Corp., AT&T; Corp. and IBM Corp.
The Chicago Board of Trade, whose name is more familiar to those wanting to set prices for future delivery of corn and soybeans, and the Chicago Board Options Exchange hope to attract small investors into the world of futures by giving them an inexpensive and simple tool to protect them from losses on the stock market.
Dow futures will allow investors to “bet” that the Dow index will stand at a certain point on a given date--say, 8040 on Thursday, or 7600 on Oct. 30.
Options and futures, while risky, can also be used as insurance. One side of the deal might be investors who don’t mind losing a little money if the Dow goes up, because it will cushion their loss if it goes down.
But with much of the expected trading likely to be small investors in an index that has a market value of $2 trillion, some are worrying that fraud and manipulation might send the stock market reeling.
“You’re going to have the wrong crowd pitching it [and] the wrong crowd trading it,” Howard Simons, director of research at FIMAT Futures USA Inc., told the Chicago Tribune last week. “I’m afraid they’re going to fleece the sheep.”
Investors will post an initial down payment of just $3,780 to buy or sell a Dow futures contract worth 10 times the cost of the Dow index, or about $80,000 today. But if the Dow were to lose 10% of its value in a given period and an investor bet that it was going to rise, he would be down $8,000 and forced to come up with an additional $4,220 to cover that bet.
Such a system could lead to turmoil if unscrupulous traders seek to manipulate either the market or investors who were not informed of the risks, critics say.
But Patrick Arbor, chairman of the Board of Trade, argued that futures and options actually reduce volatility and that the exchanges have developed electronic systems to detect potentially fraudulent activity. Average Americans also should be allowed to protect their portfolios from risk, he said.
“Americans have car insurance and homeowner’s insurance, so why can’t the average person have some way of insuring that the money they invested in stocks and mutual funds is safe?” Arbor said. “People are investing more and becoming very sophisticated.”
For example, if an investor expects all stocks in her portfolio to fall, she can also buy a bet that Dow futures also will fall, receiving money if she is correct and balancing the individual losses without having to sell stocks.
An option gives the buyer the right, but not the obligation, to buy or sell a commodity, so if an investor isn’t sure of a fall or rise, he or she can take a little longer to decide.
Dow Jones & Co., which for 15 years rejected all bids from futures exchanges for the right to use its name, also believes the exchange has worked to reduce the risk of fraud over the years, said its chairman, Peter Kann. The company will get millions a year in licensing fees from the two exchanges.
