. .. _ . . . . _ _. ‘ ‘ . ._ .. . . ,V V ‘ _ . . . . . A‘ . .. .. .. . V _ ‘ . . READ ST. AN. ANALY‘SE OF A .sm FOR momma ee- cf Ph D. Thesis far the Degr mwmsms umvisasmi _, = ROBERT CMRLES KLEMKOSKY 19?} " . ;... r.;fi .zlr v... WM? “.4: 4 4 I V a .m i m . .,. . - 4: .s.1; .‘. LIWI'RY‘ Michigan State - Univcx sic)! This is to certify that the thesis entitled A AN ANALYSIS OF A STRATEGY FOR PURCHASING STRADDLE OPTIONS presented by Robert Charles Klemkosky has been accepted towards fulfillment of the requirements for Ph . D degree in Finance ,/K/ '1 l 4]“ ' 4/6 “Wm/QM C / - Major professor Dategidf 9 7,, /6/ 7/ —'§fl\; W, .I"~ ‘ ABSTRACT AN ANALYSIS OF A STRATEGY FOR PURCHASING STRADDLE OPTIONS BY Robert Charles Klemkosky The purpose of this study was to develOp, test and analyze an investment strategy to take advantage of an increasingly volatile stock market. Straddle options appeared to be the best investment vehicle for this as they provide unparalled leverage and the possibility of large returns, the maximum loss is limited and known with certainty and the direction of future price change is unimportant. First a systematic random sample of forty stocks was drawn each year from 1961 to 1970 from the industrial common stocks listed on the NYSE. Each sample was divided into quartiles based on annual price volatility for that year. Bight types of investment factors believed to have some influence on volatility were collected for the prior year on the ten upper quartile (high volatility) and ten lower quartile (low volatility) stocks of each sample. The hypotheses of significant differences between the av- erage investment characteristics preceding the upper and Robert Charles Klemkosky lower quartile stocks were statistically tested at a level of significance of .01. The results showed that upper quartile stocks were on the average preceded by higher volatility, higher turnover, lower number of shares out- standing and lower investment quality than the lower quartile stocks. Next, the industrial common stocks listed on the NYSR possessing the above investment characteristics were selected at the end of each year from 1961 to 1969 if the year-end closing price was above $30 per share. Sixpmonth straddle options were then purchased on the first trading day of each quarter in the year following the stock's selection if the price per share was within the $30 to $100 range. Investments were made beginning with the first quarter of 1962 and ending with the fourth quarter of 1970. Rates of return were calculated for each holding period and each year with adjustments made for stock splits, dividends and commissions. It was also assumed that all straddles were held for six months and the in- vestor enjoyed a tax-exempt position. Finally, the returns were analyzed and compared with other studies involving the purchase of straddle options, with market performance and with mutual fund performance. Risk comparisons were also made using the coefficient of variation as a measure of risk. Annual rates of return were positive in six years Robert Charles Klemkosky and negative in three, resulting in an average annual rate of return of 39.5 per cent over the nine year period. Only one year, 1968, in the last six was unprofitable which is significant because the market has been more volatile since 1965. Rates of return were positive in twenty-two of the thirty-six possible holding periods and negative in the other fourteen. Two other empirical studies involving the purchase of sixpmonth straddles were available for comparative purposes. One study had a larger average rate of return than this study which could be explained by differences in purchase and exercise dates and the quality of stocks in- volved. The second study had a smaller average annual rate of return and higher risk than this study. Comparisons were also made with the returns avail- able on the Dowaones Industrial Average and Standard and Poor's 500 Stock Index over the nine year time period. The 39.5 per cent average annual return in this study was approximately six times larger than the average market return and risk was lower. A final comparison was made with growth oriented mutual funds and the average annual return in this study was approximately four times larger while risk again was lower. In summary, this strategy for purchasing straddle options has achieved superior returns in a manner that Robert Charles Klemkosky contradicts much of current financial theory. It used past, public information to consistently generate returns much larger than either market or mutual fund returns; something the broad version of the random-walk theory says is difficult to achieve. Also, these high rates of return were not earned at the expense of higher risk. Just the opposite was true, because risk was lower in all cases. This contradicts the risk-return proposition that inves- tors can realize higher rates of return only by assuming greater risk. AN ANALYSIS OF A STRATEGY FOR PURCHASING STRADDLE OPTIONS BY Robert Charles Klemkosky A THESIS Submitted to Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Accounting and Financial Administration 1971 ACKNOWLEDGMENTS The author would like to express his appreciation to Professor Alan E. Grunewald, Chairman of my disserta- tion committee, for his contributions to this study and towards my education. His contributions as well as those of Professor Leonard Rall and Professor Gardner H. Jones are also gratefully acknowledged. I would also like to express a special note of thanks to Professor James D. Edwards, Chairman of the Department of Accounting and Financial Administration, for providing the needed financial support and to several other faculty members, especially Professors Myles S. Delano and Alden C. Olson, for broadening my education in many areas. I also want to thank visiting Professor Richard Walter for valuable programming assistance and Kay Hamming for typing the manuscript. An extra special note of appreciation goes to my wife, Betty, whose encouragement and self-sacrifice made it possible for me to successfully complete my education at Michigan State University. ii TABLE OF CONTENTS LIST OF TABLES O O O O O O O O O O O O O 0 Chapter I. II. III. IV. V. INTRODUCTION A. Purpose of Study. . . . . . 3. Option Terminology. . . . . C. Purpose of Options. . . . . D. Historical Background and F Developments. . . . . . . uture Review of Literature and Research RESEARCH DESIGN A. B. C. Methodology . . . . . . . Research Terminology. . . Procedural Steps 1. Statistical Testing . 2. Selection of Stocks . 3. Purchase of Straddles 4. Rates of Return . . . 5. Comparison. . . . . . ANALYSIS OF RESULTS A. B. C. D. Hypotheses Testing. . Selection Process . . Purchase of Straddles Returns on Investment COMPARISON OF RESULTS A. B. C. D. SUMMARY, QUALIFICATIONS AND IMPLICATIONS A. B. C. Zieg's Results. . . . . . . Zweig's Results . . . . . . General Market Performance. Mutual Fund Performance . . Summary . . . . . . . . . Qualifications. . . . . . . Implications. . . . . . . . iii Page raw mo mbH 48 51 54 56 BIBLIOGRAPHY. APPENDIX A. B. C. D. Page 0 O O O O O C O O O O O O O O O O O O 93 Radon samples: 1961-700 0 e e e e 97 Investment Characteristics Preceding Upper and Lower Quartile Stocks: 1961-70eeeeeeeee es 107 Investment Characteristics Preceding Stocks Selected: 1962-70 . . . . . 117 Profit (Loss) On Straddles Purchased BaCh Period 0 O O O O O O O O O O C 126 iv LIST OF TABLES Table Page 1-1 Percentage Price Change of NYSE Common Issues . . . . . . . . . . . . . 3 1-2 Total Option Volume and Relation to Total Volume on the NYSE, 1937-1969 . . 13 2-1 Conversion of Dadekian's Evaluation of Option Bids into Bids Expressed as a Per Cent of the Striking Price. . . . . 39 2-2 Average Premiums on Three-Month and Six- Month Straddle Options Classified by Price of Stock Optioned . . . . . . . . 40 2-3 Commission Schedule . . . . . . . . . . . 45 3-1 Prior Year's Investment Characteristics of Upper and Lower Quartile Stocks. . . 50 3-2 Selection Criteria Applied to Eligible StOCks O O O O O O O O O O O O O O O O O 5 3 3-3 Number of Eligible Stocks and Actual Selections. . . . . . . . . . . . . . . 54 3-4 Number of Straddles Purchased Each Period. . . . . . . . . . . . . . . . . 55 3-5 Dollar Investment in Option by Period “6 Year 0 O O O O O O O O O O O O O O O 56 3-6 Net Proceeds Per Period . . . . . . . . . 57 3-7 Profit (Loss) Per Period. . . . . . . . . 58 3-8 Rate of Return Per Period . . . . . . . . 58 3-9 Rate of Return Per Period Restated on Annual Basis. . . . . . . . . . . . . . 59 3-10 Dow-Jones Industrial Average Percentage Moves O O O O O O O O O O O O O O O O O 61 Table 3-11 3-12 3-13 3-14 3-15 3-16 3-17 3-18 3-19 4-1 Rankings of Average Percentage Moves and Annual Rates of Return. . . . . . . Rankings of D-J IA Percentage Moves . . . Rankings of Rates of Return Per Period. . Number of Straddle Options Exercised B.Ch PerAOd O O O O O O O O O O O O O 0 Percentage of Straddle Options Exercised Each Period . . . . . . . . . . . . . . Number of Options Exercised at a Profit E.Ch Per 10d 0 O 0 O O O O O O O O O O 0 Number of Options Exercised at a Loss Each Period . . . . . . . . . . . . . . Number of Options Exercised on the Call side 0 O O O O O O O O O O O O O O O O 0 Number of Options Exercised on the Put Side.................. Investment, Net Profit and Rate of Return by Market Type . . . . . . . . . Comparison of Semi-Annual Rates of Return 0 O O O O O O O O O O O O O O O 0 Annual Rates of Return on Investment to Buyers of Six-Month Straddles . . . . . Comparison of Annualized Rates of Return. Comparison of Annual Rates of Return With Market Returns . . . . . . . . . . Comparison of Annual Rates of Return Nith Mutual Fund Performance. . . . . . 1961 Random Sample. . . . . . . . . . . . 1962 Random Sample. . . . . . . . . . . . 1963 Random Sample. . . . . . . . . . . . 1964 Random Sample. . . . . . . . . . . . 1965 Random Sample. . . . . . . . . . . . vi Page 62 63 63 66 66 67 67 69 69 71 72 75 76 79 80 97 98 99 100 101 Table Page A-6 1966 Random Sample. . . . . . . . . . . . 102 Ap7 1967 Random Sample. . . . . . . . . . . . 103 Ape 1968 Random Sample. . . . . . . . . . . . 104 A-9 1969 Random Sample. . . . . . . . . . . . 105 A-lO 1970 Random Sample. . . . . . . . . . . . 106 8-1 Investment Characteristics Preceding Upper and Lower Quartile Stocks: 1961 Sample................. 107 8-2 Investment Characteristics Preceding Upper and Lower Quartile Stocks: 1962 sample. 0 O O O O 0 O O O O O O O O O O 108 B-3 Investment Characteristics Preceding Upper and Lower Quartile Stocks: 1963 suple. O O O O O O O O O O O O O O O O 109 B-4 Investment Characteristics Preceding Upper and Lower Quartile Stocks: 1964 smple. O O O O O O O O O O O O O O O O 110 B-5 Investment Characteristics Preceding Upper and Lower Quartile Stocks: 1965 Sanple................. 111 B-6 Investment Characteristics Preceding Upper and Lower Quartile Stocks: 1966 sample. 0 O O O O O O O O O O O O O O O 112 B-7 Investment Characteristics Preceding Upper and Lower Quartile Stocks: 1967 Smple. O O O O O O O O O O O O O O O O 113 8-8 Investment Characteristics Preceding Upper and Lower Quartile Stocks: 1968 sample. 0 O O 0 O O O O O O O O O O O O 114 8-9 Investment Characteristics Preceding Upper and Lower Quartile Stocks: 1969 sample. 0 O O O O O O O O O O O O O O O 115 B-10 Investment Characteristics Preceding Upper and Lower Quartile Stocks: 1970 Samples 0 O O O O O O O O O O O O O O O 116 vii D-B Page Investment Characteristics Preceding Stocks Selected for 1962. . . . . . . . 117 Investment Characteristics Preceding Stocks Selected for 1963. . . . . . . . 118 Investment Characteristics Preceding Stocks Selected for 1964. . . . . . . . 119 Investment Characteristics Preceding Stocks Selected for 1965. . . . . . . . 120 Investment Characteristics Preceding Stocks Selected for 1966. . . . . . . . 121 Investment Characteristics Preceding Stocks Selected for 1967. . . . . . . . 122 Investment Characteristics Preceding Stocks Selected for 1968. . . . . . . . 123 Investment Characteristics Preceding Stocks Selected for 1969. . . . . . . . 124 Investment Characteristics Preceding Stocks Selected for 1970. . . . . . . . 125 Profit (Loss) On Straddles Purchased In 1962 O O O O O O O O O O O O O O O O 126 Profit (Loss) On Straddles Purchased In 1963 O O O I O O O O O O C O O O O O 127 Profit (Loss) On Straddles Purchased In 1964 O O O O O C O O O O O O O O O O 128 Profit (Loss) On Straddles Purchased In 1965 O O O C O O O C C O O O O O O O 129 Profit (Loss) On Straddles Purchased In 1966 O O O O O O O O O O O O O O O O 130 Profit (Loss) On Straddles Purchased In 1967 O O O C O O O O O O O O O O O O 131 Profit (Loss) On Straddles Purchased In 1968 O O O O O O O O O O O O O O O 0 132 Profit (Loss) On Straddles Purchased In 1969 O O O O C O O O O O O O O O O O 133 viii Table Page D-9 Profit (Loss) On Straddles Purchased In 1970 O O O D O O O C O O C O O O O O 134 ix CHAPTER 1 INTRODUCTION Pugpgse of Study The purpose of this study is to develop and test an investment strategy that takes advantage of important changes that have occurred in common stock investing over the past decade. One development has been a stock market that has come more and more under the influence of institutional investors. The latest New York Stock Exchange statistics reveal that they now account for 65 to 70 per cent of total NYSE volume which is quite an increase over their 31.4 per cent share in 1960 and only 43.0 per cent as recently as 1 1966. This is also reflected in the number of block transactions of 10,000 shares or more on the New York Stock Exchange which totaled 15,132 in 1969 versus only 2 2,171 in 1965. This block volume as a per cent of total NYSE volume rose to 14.1 per cent in 1969 from only 3.1 per cent in 1965.3 1New York Stock Exchange 1970 Fact Book, June, 1970, p. 50. 21bid., p. 12. 31bid., p. 12. 2 Another important development has been the change in investment philosOphies by many of todays institutional investors. For many, this investment philosophy can be summed up by one word--performance. The quest for short- term performance has undoubtedly increased the pace of the stock market. Trends which used to take years to run their course now do so in months and the whole process of stock prices discounting future deve10pments has acceler- ated. As a consequence, institutional portfolio turnover rates have increased dramatically: there are at least triple the 1965 rates for most institutions.4 The impact of this increased institutionalization of investing and increased turnover activity has been a more volatile stock market. This is illustrated by Table 1-1 which shows the percentage price changes of common stock issues in comparable bull and bear market years. The number of issues changing by forty per cent or more in 1967 was twice as great as that in 1961 and nearly three times as great in 1969 compared to 1962. A recent Twentieth Century Fund study also sup- ports the hypothesis that institutional investors have an impact on short-term price changes of specific stocks, 4Alan Abelson, ”Up and Down Wall Street“, Barron's, June 21, 1971, p. 1. 3 especially high risk stocks.S Table 1-1 Percentage Price Changes of NYSE Common Issues Percentage Bull Markets Be Markets Price Change 1961 1967 1962 1569 50% and Over 171 426 44 156 40-49.9% 74 87 72 166 30-39.9% 151 126 169 196 20-29.9% 191 139 235 287 10-19.9% 234 214 304 175 Under 10.0% 14 6 10 3 Total Issues 1088 1206 1120 1202 Source: 1970 New York Stock Exchange Fact Book, p. 18, and 1966 New York Stock Exchange Fact Book, p. 24. Straddle options appear to be ideal investment vehicles for taking advantage of this increased price volatility. They provide unparalled leverage and the possibility of large returns. Yet the maximum loss is small and certain: it can't be greater than the premium paid. And perhaps their most important feature is in- difference to the direction of future price changes. They should fare well in increasingly volatile markets, es- pecially since 1965. SIrwin Friend, Marshall Blume and Jean Crockett, Mutual Funds and Other Institution 1 Investors: A New Persggctive, (New‘York: McGraw-Hill Book Co., 19705, Chapter 5. 4 Two empirical studies have shown that buyers of straddle Options have enjoyed positive rates of return over various time periods. This study will attempt to devise a strategy for purchasing straddle Options to improve upon these results as well as market and mutual fund perform- ance. Option Terminolggy The following terms are essential for understand- ing this study. Call Option. A call option gives the holder or buyer the right to purchase a specified number Of shares- usually one hundred-at a fixed price anytime within a specified period Of time. The maker or writer of a call option is obligated to sell the shares at a specified price if the buyer chooses to exercise the option. The premium paid for a call option is essentially payment for the possibility of being able to buy one hundred shares of stock at less than its current market value. Put tion. A put option gives the holder or buyer the right to sell a specified number of shares- usually one hundred-at a fixed price anytime within a specified period of time. The maker or writer Of the put option is obligated to buy stock at a specified price if the buyer chooses to exercise the option. The premium paid for a put Option is payment for the possibility of being able to sell one hundred shares of stock at a price above its current market value. 5 Straddle ggtion. A straddle is a combination of one call and one put Option on the same stock, exercisable at the same price and having the same maturity dates. The buyer Of the straddle has the Option Of exercising either the put, the call, or both at the market price existing at the time Of purchase. The seller or writer Of the straddle is obligated to buy one hundred shares at a specified price if the buyer exercises the put Option, tO sell one hundred shares at the same specified price if the buyer exercises the call Option or to both buy and sell at the same price if the buyer chooses to exercise both sides of the straddle. Option writers usually sell straddles be- cause the premiums are higher than put or call premiums and the probability of both sides being exercised is very small. Writer. One who sells Options against either a long, short or cash position. The writer Of a call Option protects himself against extraordinary losses by main- taining a long position in the stock while the put writer would maintain a short position for protection. Cash can be substituted for either the long or short position by writers but the protection is not as adequate. writers are usually large individual stockholders or institutions wanting to increase rates Of return on their portfolios. Striking Price. This is the specified price at which the Option may be exercised and is usually the market price existing at the time the contract is negotiated. 6 Special Options are available where the striking price is not the same as the market price and are frequently adver- tised for sale in the Wall Street Journal and the financial section of the New York Times. Premium. The premium is the consideration paid by the buyer to the seller for the privilege Of purchasing the Option. The premium is paid by the buyer because only he has the right to exercise the Option anytime within the length Of the contract. Also, the buyer's potential re- turns are unlimited and losses limited. Conversely, the seller's gains are limited to the amount of the premium received plus the possibility exists that he may have to sell in an advancing market or buy in a declining market. The price of the Option premium is determined by the following factors: 1) The absolute price Of the underlying stock. 2) The expected rate of appreciation or depre- ciation of the stock and current market trends. 3) The variance or volatility Of the underlying stocks. 4) The length of the option contract. 5) Investment quality Of the underlying stock. 6) Cost Of capital and Federal Reserve margin requirements. 7) The floating supply and trading turnover of the underlying stock. 8) Supply Of and demand for Options in general. Time Period. The time period in which an option expires is usually 65 days, 95 days or six months and ten days (190 days) although 35 day and one year Options are available. The additional 10 days on the six-month Option are necessary to take advantage of the long-term capital gains tax. Endorser. Every Option contract must be endorsed by a member firm Of the New York Stock Exchange. This means that the member firm guarantees completion of the contract on the part of the writer. The writer of a call Option usually has a long position in the stock or main- tains an initial minimum margin requirement Of thirty per cent cash while the writer Of a put Option must be short the stock or maintain an initial minimum margin require- ment Of twenty-five per cent cash. Most member firms generally require a larger margin requirement than that stated above. Brokers and Dealers. There are thirty members of the Put and Call Brokers and Dealers Association with about twenty actively engaged in the Option business. All Of the members are brokers in Options but only some are also dealers who take a position on one side Of the Option contract and thus undertake additional risk. Most Option business generally starts with a stockbroker who uses the Option broker tO facilitate his order whether it be on the buying or selling side. 8 Bid Sheets. These are sheets sent out daily by the active members of the Put and Call Brokers and Dealers Association and are summaries of bids made to Option writers on that particular day. Each bid sheet contains the ticker symbols for the securities involved, the type Of Option being bid for, the Option life desired, and the actual premium, net Of endorsement fees, the bidder is willing to pay the writer. The writer can either accept the terms as stated on the bid sheet or negotiate for changes. Conversion. The demand Of buyers is generally much greater for call Options than put Options whereas writers prefer to sell straddles because of the higher premium. This creates an excess supply Of put Options and explains why call premiums are always larger than put premiums, other things equal. However, the possibility Of Option conversion limits the spread between put and call premiums irrespective of buyer's demands. This conversion is accomplished in the following manner: the conversion house simultaneously buys a put, buys 100 shares of the associated security and writes a call Option. Since this position is unaffected by any possible price change, the converter assumes no risk and still brings about equil- ibrium in the Option market. Puppgse of Options Two main reasons for purchasing Options are (1) protection and (2) speculation. First, Options can be 9 used to reduce risk in normal stock market transactions through a hedging process. For example, an investor with a profitable long position in a common stock may purchase a put Option to protect against a price decline. If this happens, the put Option gives him the privilege Of selling his stock to the Option writer at the striking price which would be above the market price. If the stock continues to advance, the investor lets the Option expire without exercising it and makes money on his long position. Like- wise, an investor who sells a stock short may purchase a call Option to protect against a dramatic price increase. If this happens, he can call or buy the stock at the striking price which would be below the market price tO cover his short position. If the price declines as anti— cipated, he will let the call expire and make money on the short sale. Many books such as Herbert Filer's Understanding Put and Call Options are available which explain numerous other ways in which Options can be used to reduce risk in stock market Operations. These all sound good in theory, but available evidence indicates that protection is not very Often a motivating factor for purchasing options.6 The second and most important reason for purchasing 6A. James Boness, analyzed 490 actual Option transactions and found no instances of using Options for protection. The Random Character of Stock Market Prices, ed. Paul H. Cootner, (CambrIdge, Mass.: The M.I.T. Press, 1964), p. 475-496. 10 Options is speculation. Options provide unparalleled leverage to the buyer and thus the possibility of un- limited returns. But they also provide limited and cer- tain risk because any loss can not be greater than the premium paid. Additionally, straddle buyers can be in- different to the direction of future price changes be— cause they can exercise either the put or call side. Considering the speculative appetite of many investors, it is easy to understand why Options are appealing. Writers usually sell Options to increase rates of return on their portfolios. Because the majority Of Options are either not exercised or are exercised at a loss to the buyer, the Option premiums are additional income to the writers. Option writing appeals to large individual stockholders with a percentage-minded invest— ment philosOphy since any gain is limited to the Option premium and the possibility Of unlimited losses exists. Writers generally prefer to sell straddle Options since the premium is larger and the probability Of both sides of the Option being exercised is low. Historical Background and Future Developpents Although the Option market is one of the fastest growing segments Of the investment field, it is not readily understood by the investment community nor has it received much attention from academicians. This may be because Options have been considered as the "black sheep“ Of the securities field, a reputation which could have been 11 justified prior to the 1930's but certainly not since that time. Options made their first major economic impact during the tulip bulb craze in seventeenth-century Holland.7 They were first used for hedging purposes by the traders and growers but later became a favored instru- ment Of speculation. The major attention of the traders became the writing and trading Of Options rather than the buying and delivery Of tulips. The put writing traders and call buyers amassed fortunes as tulip prices continued to spirale while the call writing traders and put buyers, though fortunately few in number, lost money. When tulip prices collapsed, put writers could not meet their committ- ments to purchase tulips at prices far above current market prices and thousands of investors went bankrupt. During the subsequent economic depression, much discredit was placed upon put and call Options as they acquired their first taint of disrepute. In London, there has been a well organized option market since the 1690's, although Options dealings were banned several times over this time period.8 Since WWII, Options activity has declined considerably compared to 7Anthony M. Reinach, The Nature of Puts and Calls, (New York: The BoOkmailer, Inc., 1961), p. -23. 8B. Victor Morgan and w. A. Thomas, The Stock Exchange, (London: Elek Books, 1962), p. 21. 12 prewar activity and London is no longer the major Option market center it once was. In this country, stock Options unfortunately first enjoyed wide popularity during the bull market Of the 1920's; unfortunate because this was also the period when there were many abuses related to the use Of Options. Pool Operators using Options to manipulate stock prices, brokers given Options for pushing certain stocks and the use Of one-day or two-day Options were a few of the abuses cited in those days. Congress came close to ban- ning all Options but in the end the Securities and Ex- change Commission was empowered tO regulate the Option brokers and dealers. After passage of the Securities Act Of 1934, the Put and Call Brokers and Dealers Association (P & C B a DA) was formed to represent the Option firms and to impose self-regulation on the Option business. The new powers Of the S.E.C. and the P a C B 5 DA have been very effective in eliminating past abuses because since 1935 the Option business had had an untarnished record. In response to this added confidence, Table 1-2 shows that absolute Option volume has increased dramat- ically between 1937 and 1969 but relative option volume has not grown since 1960. Continuance Of this past growth will be assured if four things can be accomplished. One is the develOp- ment Of a central market place which can increase the 13 Table 1-2 Total Option Volume and Relation to Total Volume on the NYSE, 1937-1969 Total Shares Ratio of Option Volume Year Optioned (000's) to NYSE Volume 1937 2,246 .55 1940 1,205 .58 1945 2,108 .56 1950 2,631 .50 1955 6,012 .93 1960 8,561 1.12 1965 15,256 .98 1968 30,284 1.05 1969 28,265 1.03 Source: Securities and Exchange Commission, Repgrt on Put and Call Options, p. 20, and Barron's, NOvember 30, 19 0, p. 5. efficiency Of bringing buyer and seller together. The present system is costly and laborious as well as time- consuming. What is needed is an auction type market to replace the present system. The Chicago Board Of Trade is studying the possibility Of starting a future type market for puts and calls on active Option stocks with the Objective of attracting institutional business.9 Also, a firm called Market Monitor Data, Inc., has already set up a computerized network to furnish bids and offers on puts and calls to hopefully facilitate the process Of 9Margaret D. Pacey, "Options Pick Up“, Barron's, September 21, 1969, p. 11. l4 bringing option writers and buyers together.10 A second requirement is the development of a secondary market for the trading of existing options. Under the present system, the vast majority of options are exercised or allowed to expire by the original pur- chaser which is due to the inefficiency and lack of know- ledge about trading existing options. The former Good- body and Co. (now part of Merrill, Lynch, Pierce, Penner and Smith Inc.) began in 1968 to make a continuous sec- ondary market in options on a limited number of issues. A third requirement is for the Put and Call Brokers and Dealers Association to educate the investing public and professional investment managers about the merits of both buying and selling option contracts. Laurence Botts, partner of Thomas, Haab & Botts, the largest option firm, estimates that 80 per cent of every- one interested in the stock market doesn't know what puts and calls are.11 An information gap of this magnitude must be closed by those in the business. The last requirement is that the traditional and legal constraints confronting institutions wanting to deal in options must be removed. Many states prevent in- stitutional investors under their jurisdiction from 1°Ibid. 11""1‘raders Take to an Arcane Art“. _______——3“51"953 Week, MCHLXVll (May 13, 1967), p. 157. 15 writing or buying options and the tax rulings of the In- ternal Revenue Service certainly haven't helped to promote option writing. Perhaps if the first three requirements are met, this one will follow in place. Review of Literature and Research Most research on options has attempted to determine the general experience of option writers and buyers. Since writers are generally large stockholders and buyers small stockholders, most peOple naturally assume that op- tion writing is profitable and option buying unprofitable. Others believe that bothvuiters and buyers lose and the only winners are the brokers and dealers. This is the question that researchers have attempted to answer and the results thus far are inconclusive. Richard Kruizenga was the first to attempt an answer to this question when he wrote his Ph.D. disserta- tion on this topic in 1956.12 He used nominal Option quotations submitted weekly during 1946-1956 to the S.E.C. by the P & C B & DA to ascertain the returns from purchasing or writing put and call options and concluded the following: 1) Purchasing 90-day call options over the ten year period was profitable (9% annual return 12Richard J. Kruizenga, “Profit Returns from Pur- chasing Puts and Calls", The Random Character of Stock Market Prices, ed. Paul H. Cootner, (Cambridge, Mass.: The M.I.T. Press, 1964), pp. 392-411. 16 on investment) and purchasing 90-day put Options over the same time period was unprofit- able. By eliminating the 1953-1956 bull market period from the study, purchasing 90-day puts and calls were both unprofitable. 2) Purchasing 6-month call Options over the ten year time period was profitable (35% annual return) and again - purchasing 6-month put options was unprofitable. Six month call Options were still profitable after elimin- ating the 1953-1956 bull market period. 3) Option writers would have shown losses when the results of their Option writing were com- pared to the Opportunities available by just holding the stock. This study has some limitations which should be pointed out. First, nominal quotations were used instead of actual quotations and since these are usually higher, this produced a downward bias to the returns from pur- chasing Options. And second, the sample is heavily weighted with blue chip stocks having low volatility and no implications from this study should be made toward highly volatile stocks. James Boness disagreed with Kruizenga in his 17 study.13 He analyzed 490 actual Option transactions from July, 1957 to July, 1960, and found that purchasing options of any type was tremendously unprofitable (82.2% annual loss on investment). The shorter the duration of the option contract the greater the annual loss and purchasing puts on the average was more unprofitable than calls. Boness assumes three different strategies for the option writer. The adventurous strategy was to sell the Options naked, meaning to simply deposit the minimum re- quired margins. The conservative strategy was to sell the Options and maintain a long or short position in the stock depending On the type Of option. And the sophisticated strategy employed a filter technique whereby a naked position was covered by a long or short position if the price of the stock changed by ten per cent in either direc- tion. Using the adventurous and conservative strategies, the writer would not do as well as simply buying and hold- ing the stock while the soPhisticated strategy would earn the writer an average annual rate of return of 32.9 per cent. Limitations Of this study are the short time period involved, three years, and the small number Of transactions used in the analysis. The S.E.C., in its 1961 Repgrt on Put and Call 13A. James Boness, ”Some Evidence on the Profita- bility of Trading in Put and Call Options”, in Cootner, OE. Cite. pp. 475-4960 18 Options, studied all call Options either outstanding or sold during June, 1959 and verified some long-standing beliefs about the Option business.14 First, call buyers exercised only forty-two per cent of Options purchased and half of these were exercised at a loss, meaning a profit was made only twenty per cent Of the time. Second, a marked contrast between option buyers and Option writers was noted as Option writers consisted primarily of wealthy individuals and a few in- stitutions whereas Option buyers generally were individual investors possessing limited amounts Of funds. And third, option activity had increased about six-fold between 1934 and 1960. The major drawback of this study is that only a short period of time and one type of market is covered. Since the market peaked in July, 1959, and fell continu— ously until September, 1960, it is not surprising that call buyers fared poorly. It should have estimated the profit- ability of put and straddle buying as well as all types of option writing. Richard Katz studied 851 option contracts sold by 76 writers between April, 1960 and January, 1962 and con- cluded that both option writers and buyers lost slightly 14Securities and Exchange Commission, Repprt on Put and Call Options, (Washington, D.C.: 0.3. Government Printing Office, August, 1961). 19 on their Option dealings.15 However, writers would earn a slight profit if they received the entire premium paid by the buyers. Zieg attempted to improve upon the S.E.C. study by calculating average rates of return accruing to option writers and buyers for six different types of markets in- stead of one.16 He choose the following dates to repre- sent his six market types: 1) September 23, 26, and 27, 1965 to represent a top-turn-around market which continues to rise for four months, peaks, and declines. 2) February 8, 9, and 10, 1966 to represent the highest point of the bull market. (DowaJones Industrial Average 995.15). 3) April 20, 21, and 22, 1966 to represent a down market which continues to decline for six more months. 4) May 23, 24, and 25, 1966 to represent a bottom- turn-around market which continues to fall for four months, hits a low point and recovers. 5) October 6, 7, and 10, 1966 to represent the 15Richard Katz, “The Probability of Put and Call Option Writing", Industrial Management Review, V (Fall, 1963), p. 55-69. 16Kermit c. Zieg, Jr., A Study of Common Stock Options from the Standppint of the Returns Accruing to the Buying and Selling Sides, published Ph.D. Thesis, Dept. Of Business Organization, The Ohio State University, Columbus, Ohio, 1968). 20 lowest point of this bear market. (Domeones Industrial Average 744.32). 6) January 11, 12, and 13, 1967 to represent an up market which continues to advance for at least six months. All options (2,212) appearing on the bid sheets received by the Chicago office of Francis I. duPont and CO. for these eighteen days were then assumed to have been purchased and written simultaneously under the terms called for on the bid sheets except that buyers' premiums are adjusted upward. Zieg's results showed that Option writers would have lost an average of 7.3 per cent on their investment in puts, 1.3 per cent in calls and 12.7 per cent on strad- dles. Conversely, Option buyers would have earned large average rates of return on investment; put buyers enjoyed a return of 69.0 per cent, call buyers 41.5 per cent and straddle buyers 61.4 per cent. Because straddle buyers earned positive rates of return for all eighteen writing dates versus six for the put buyer and nine for the call buyer, there was less risk involved in purchasing stradp dles, assuming risk is measured by variance of return. There are some serious limitations to this study. First, the time period covered was too short (21 months) to make any generalizations about Option writing versus Option buying. Second, this market was not very repre- sentative because it was more volatile than normal; the 21 Dow-Jones Industrial Average dropped 250 points in eight months and then quickly recovered to approach the former highs. And thirdly, the results are biased because the market is not at a peak or trough two-thirds Of the time as his market dates are. Under these circumstances, it is not surprising that Option buyers fared so well. Probably the most conclusive empirical study was done by Martin Zweig who calculated return-risk ratio's 17 The for fifty-seven different investment strategies. option buying strategies were classified by type of Option, put, call or straddle, length of Option, three months or six months, and volatility, low, medium, or high, giving eighteen possible combinations of buying strategies. The option writing strategies were classified similarly except that positions could be covered naked or with stock, re- sulting in thirty-six possible combinations of writing strategies. The control strategies consisted of investing in low, medium, and high volatile stocks. His methodology was to randomly select ten stocks each year in each vola- tility class from those stocks appearing on the bid sheets of Thomas, Haab & Botts. He then wrote and purchased options on a monthly basis for one year after selecting the thirty stocks and repeated this for seven years, from 17Martin E. Zweig, An anal sis of Risk and Return on Put and Call Option Stratggies, (unpublished Ph.D. Thesis, Department of Accounting and Financial Administra- tion, Michigan State University, East Lansing, Michigan, 1969). 22 mid-1961 to mid-1968. Returns and return-risk ratios were computed annually for each of the fifty-four option strat- egies and three control strategies and then averaged over the seven year time period. Return-risk ratios were cal- culated by subtracting a risk-free rate of return from each annual rate of return and dividing by the seven year standard deviation of returns. Zweig concluded that investors had superior per- formance investing in stocks as Opposed to either buying or writing options when performance was measured by the return-risk ratio. Five of the eighteen Option buying strategies had positive average return-risk ratios while only one of the thirty-six writing strategies had. If performance was measured by average rate of return on in- vestment, purchasing calls or straddles on highly volatile stocks as well as purchasing medium and high volatile stocks were the superior strategies. Four Option writing strategies had positive average rates of return but all were low. Finally, Malkiel and Quandt developed the most 18 Their theoretical study of option strategies to date. approach incorporated hypothetical investor utility func- tions and decision making under uncertainty into an 18Burton 6. Malkiel and Richard B. Quandt, Strat- ies and Rational Decisions in the Securities 0 tions Markets, (Princeton, New Jersey: Princeton University Financial Research Center, 1968). 23 analysis of Option strategies under different market con- ditions and states Of expectations. They compute the re- turns from sixteen different investment strategies Of which eleven pertain to buying or writing Options, four to buying or shorting the stock and one to a cash position. The authors conclude that the use of stock Options by both buyers and sellers is rational and should be part of overall portfolio strategy. Generally, strategies in- volving option writing predominated over option buying strategies. This study also has some serious drawbacks. First, only NYSE stocks selling between $45 and $55 per share on January 1, 1960 thru 1964 were used for possible Option transactions. This sample may not be representative of all NYSE stocks and perhaps no option activity existed on some Of the stocks in the sample. Second, option premium data were gathered from 1964 through 1966 and then applied to hypothetical transactions from 1960 to 1964. Option pre- miums in the period 1964 to 1966 may not be representative of Option premiums in the period of 1960 to 1964. And third, Malkiel and Quandt ignore the extreme tails of theoretical probability distributions of stock prices and it is these extreme fluctuations that make Option writing hazardous and option buying profitable. Some limited research has been done on the deter- minants Of Option premiums with three published studies thus far. Franklin and Colberg used simple linear 24 regression to test the relationship between thirty-eight put and call premiums and the absolute prices of the associated stocks on October 17, 1955.19 They found that for both puts and calls, the relationships were linear, coefficients of correlation high and standard errors Of estimate low. In other words, the absolute price of the stock was a good predictor of the put or call premium. In a more sophisticated study, Malkiel and Quandt used multiple regression analysis to find the determinants of prices paid to option writers of 106 calls and 61 straddles during the year-end periods of 1964, 1965 and 1966.20 They found the market price of the stock, the past volatility, the number of shares outstanding, the turnover ratio and the expected long-term growth rate for earnings to be important determinants of call premiums. The same factors with the exception Of the expected long- term growth rate of earnings were significant in deter- mining straddle premiums. Finally, Stoll tested to see if an arbitrage mechanism existed to keep put and call prices in line with 21 each other irrespective of the demands of buyers. He 19Charles B. Franklin and Marshall R. Colberg, "Puts and Calls: A Factual Survey", Journal of Finance, Vol. XIII, NO. 1 (March, 1958), p. 21-34. zoMalkiel and Quandt, Op. cit., pp. 26-31. 21Hans R. Stoll, “The Relationship Between Put and Call Option Prices“, Journal of Finance, Vol. XXIV, NO. 5 (December, 1969), pp. 801-824. 25 found a parity between put and call prices and concluded that relative put and call prices differ by the pure rate of interest. The vast majority of literature on options has appeared in the widely read business magazines and news- papers such as Business Week, thelgpgazine of Wall Street, Forbes, Financial World, Barron's, the.!pll Street Journal and the Commercial and Financial Chronicle. With very few exceptions, these articles have been explanatory in nature and Of little help to the sOphisticated investor. CHAPTER 2 RESEARCH DESIGN Methodology The methodology consists of three main parts: statistical testing (Step 1), application (Steps 2 and 3) and analysis (Steps 4 and 5). Step 1. Isolate those investment factors that are statistically significant in predicting annual price volatility. A systematic random sample of forty stocks is drawn at the end of each year from 1961 to 1970, from the population of industrial common stocks listed on the New York Stock Exchange. Each sample is divided into quar- tiles based upon volatility for that year and differences between the investment characteristics preceding the upper (high volatility) and lower (low volatility) quartile stocks are tested using a nonparametric statistical test. Step 2. Select annually from the population of industrial common stocks listed on the NYSE and selling above $30 per share, those having the investment char- acteristics associated with high volatility as established in Step 1. Step 3. Purchase one six-month straddle Option on the first trading day of each period (January, April, July 26 27 and October) on each stock selected in Step 2. If the market price falls below $30 or rises above $100 per share on any purchase date, a straddle is not bought at that time. The premiums paid for the straddle Options are estimated as actual premiums are difficult to Obtain. Step 4. Calculate and analyze the rate of return on investment for each period and an annual rate of return for each year. Assumptions are made about holding periods, investment bases and the tax status and adjustments are made for dividends, splits and brokerage commissions. Step 5. Compare the rates of return in the study with the results of other empirical studies involving the purchase of straddle Options, with market performance and also with mutual fund performance. The riskiness Of these annual rates of returns are also calculated using a rela- tive measure of dispersion as a measure of risk. Resegpch Terminology Some of the terminology and measurements used in this research design are as follows: Volatility. This will always refer to annual price volatility unless stated otherwise. It is measured by the annual price range divided by the mid-range or in alge- braic terms, V 3 Ph - Pl where Ph is the high price for m the year and P1 is the low price of the year. Holding Period. All holding periods are of six months duration and commence on the first trading day of 28 one quarter and end on the first trading day of the following second quarter. Each year will thus consist of four holding periods as follows: 1) 2) 3) 4) The first period starts on the first trading day of the first quarter (January) and ends on the first trading day of the third quarter (July). The second period starts on the first trading day of the second quarter (April) and ends on the first trading day of the fourth quarter (October). The third period starts on the first trading day Of the third quarter (July) and ends on the first trading day of the first quarter (January) of the following year. The fourth period starts on the first trading day of the fourth quarter (October) and ends on the first trading day of the second quarter (April) of the following year. Since this study covers nine years, there are thirty-six holding periods in which investments are made and rates Of return calculated. Investment nglity. The ratings assigned by Financial World are used as measures Of investment quality. They are based not only on earnings and dividend stability but also on financial condition. A+ and A stocks are investment grade issues which 29 have such attributes as a conservative capitalization, consistent dividend record and substantial earning power even under the most adverse general business conditions. Those in the A+ category have shown greater earnings consistency than stocks rated A. B+ and B stocks are upper medium to medium grade issues of semi-investment quality. They are fortified by a good financial position and satisfactory average earnings. C+ and C stocks are those in fair to good financial position. Earnings of both the semi-speculative C+ and the more speculative C rated issues depend upon general business conditions. D+ and D issues are highly speculative and un- suited for the average investor. The D issues are in a somewhat more marginal position than the D+ issues. Turnover. This is measured by dividing annual volume by the number of shares outstanding at the year- end with adjustments made for stock splits and large stocks dividends but not for other minor changes in shares outstanding. PricelEgrnings Ratio and Dividend Yield. These are obtained from Value Line's Survey and are average annual amounts, calculated from quarterly figures. They are more representative than a figure based on a single point Of time such as year-end. Shares Outstanding. These are the number of shares 30 outstanding at a point in time and are not average figures. The point in time is usually the end of the third quarter (September 30) for the majority of companies and is used because the year-end amounts are not usually published until some time in the following year. Percentage Move. This is measured by dividing the net price change for the year by the beginning of the year price. Again adjustments are made for stock splits and large stock dividends. 5535. This is measured by the coefficient of variation which is a relative measure Of dispersion. It is calculated by dividing the standard deviation by the corresponding mean. HO ppd Hi. These are standard statistical nota- tions for the null hypothesis and the alternative hypothe- sis respectively. Wilcoxon Matched-Pairs Test. This test uses both the magnitude and the direction of differences between pairs of data, by first finding the absolute differences between data and then ranking them from smallest to largest. Then the signs of the original differences are attached to the ranks and the ranks having (+) signs and (-) signs are each summed. The statistic for this test is usually denoted by T(+) - T(-) where T(+) represents the sum of the positive ranks and T(-) the sum of the negative ranks. Small absolute values of the difference T(+) - T(-) favor the hypothesis of symmetry or identity 31 of the distribution while large absolute values indicate differences in the distribution. Procedural Steps Step 1. Statistical Testing. A systematic random sample of forty stocks is drawn each year—end from 1961 to 1970. Only the industrial common stocks listed on the NYSE having a year-end closing price Of $30 per share or above are included in the pOpulation from which the ran- dom sample is drawn because most Of the Option activity is centered in these stocks and many of the highly volatile stocks are included in this group also. The number of stocks in each sample and the number of samples drawn are of sufficient size to test for the factors that are statistically significant in predicting future volatility. Each random sample is divided into quartiles based on annual price volatility. Investment information for the year preceding each sample year is then collected on the ten upper and ten low quartile stocks of each sample. For example, 1965 investment information is gathered on the ten upper and lower quartile stocks from the 1966 random sample and a similar procedure is repeated for the other nine years. It is hOped that the average investment characteristics preceding highly volatile stocks are significantly different from those preceding low volatile stocks. The investment characteristics and the reasons for testing include the following fundamental and technical 32 factors. Volatility. There appears to be a relationship between a stock's volatility one year and its volatility the following year. Altman and Schwartz studied weekly volatility measures on twenty stocks from 1962-68 and con- cluded that interfirm volatility rankings remain quite consistent over time; firms which rank low (high) in volatility at one point in time are expected to rank low (high) at other points of time.1 Pratt also found consid- erable evidence that the relative volatility exhibited by any stock has tended to persist over time.2 Turnover. The general idea here is that actively traded stocks respond more readily to general market movements than inactively traded ones. This is substan- tiated by a 1966 study by Heins and Allison which found that highly active stocks had greater price variability than less active stocks.3 Price‘Earnings Ratio. Market practioners gener- ally relate the risk Of a specific stock to its 1Edward I. Altman and Robert A Schwartz, “Common' Stock Price Volatility Measures and Patterns", Journal of Financial and guantitative Analysis, Vol. IV, NO. 5 2Shannon P. Pratt, Relationshi Between Risk and Rate of Return for Common Stocks, (Unpublished D.B.A. dissertation, Indiana University, 1966). 3A. James Heins and Stephen L. Allison, ”Some Factors Affecting Stock Price Variability“, Journal of Business, Vol. XXXIX, NO. 1 (January, 1966), pp. 21-22. 33 price/earnings ratio. Heins and.Allison found some evi- dence that A rated stocks with a higher price-earnings ratio tended to experience greater price variability than their lower ratio counterparts, but this effect did not show up in the B rated group.4 Dividend Yield. The total return to the common stockholder consists of the dividend yield plus the cap- ital gains yield. The larger the dividend yield relative to the expected capital gains yield, the less volatile the market price should be. Thus stocks having low divi— dend yields should be more volatile than those having high dividend yields. Investment Quality. Heins and.Allison also found that relative price variability is not related to the average price of the stock but to its investment grade which is highly correlated with average price.5 Thus the stocks of lower investment grade should be more volatile than high grade stocks. Percentage Move. There have been numerous in- stances where stocks enjoyed large percentage price moves upward one year only to fall sharply the following year and vice versa. This could be in response to the general market or to specific company or industry develOpments which are over-discounted. The idea is that the stocks 4Ibid., p. 22 sIbid., pp. 19-21. 34 having large percentage price moves one year are highly volatile the next year. Absolute Price. Although Heins and Allison found that relative price variability is not related to the average price of the stock, this is tested again in a different manner.6 The preceding year-end closing prices are used to determine if a relationship exists between these prices and volatility the following year. After collecting this data, averages for each of the eight investment characteristics are computed on the ten upper and ten lower quartile stocks of each sample. For example, the 1965 turnover ratios are averaged for the upper quartile stocks of the 1966 sample and the lower quartile stocks of the same sample and this is repeated for the other nine years. The Wilcoxon matched-pairs test is used to test the hypothesis of a significant directional difference between the average investment characteristics preceding the upper and lower quartile stocks.7 1) Ho: The average volatility preceding upper quartile stocks is less than or equal to the average vola- tility preceding lower quartile stocks. Hi: The average volatility preceding upper 61bid. pp. 19-21. 7See W. J. Conover, Practical Non rametric Sta- tistics, (John Wiley & Sons Inc., New York: 1971), pp. 206-215. 3S quartile stocks is greater than the average volatility preceding lower quartile stocks. 2) Ho: The average turnover preceding upper quartile stocks is less than or equal to the average turn- over preceding lower quartile stocks. Hi: The average turnover preceding upper quartile stocks is greater than the average turnover pre- ceding lower quartile stocks. 3) Ho: The average number of shares outstanding preceding upper quartile stocks is greater than or equal to the average number of shares outstanding preceding lower quartile stocks. Hi: The average number of shares outstanding preceding upper quartile stocks is less than the average number of shares outstanding preceding lower quartile stocks. 4) Ho: The average P/E ratio preceding upper quartile stocks is less than or equal to the average P/E ratio preceding lower quartile stocks. Hi: The average P/E ratio preceding upper quartile stocks is greater than the average P/E ratio pre- ceding lower quartile stocks. 5) Ho: The average dividend yield preceding upper quartile stocks is greater than or equal to the average dividend yield preceding lower quartile stocks. Hi: The average dividend yield preceding upper quartile stocks is less than the average dividend 36 yield preceding lower quartile stocks. 6)* Ho: The average investment quality preceding upper quartile stocks is greater than or equal to the average investment quality preceding lower quartile stocks. Hi: The average investment quality preceding upper quartile stocks is less than the average investment quality preceding lower quartile stocks. 7) Ho: The average percentage move preceding upper quartile stocks is less than or equal to the average percentage move preceding lower quartile stocks. Hi: The average percentage move preceding upper quartile stocks is greater than the average percent- age move preceding lower quartile stocks. 8) Ho: The average absolute price preceding upper quartile stocks is greater than or equal to the average absolute price preceding lower quartile stocks. Hi: The average absolute price preceding upper quartile stocks is less than the average absolute price preceding lower quartile stocks. *Since high quality stocks are assigned small numbers and low quality stocks have high numbers, the upper quartile stocks will have higher average numerical ratings than the lower quartile stocks if the null hypothesis is to be rejected and the alternative accepted. Step 2. Selection of Stocks. The stocks that are selected for purchasing straddles each year will possess all of the investment characteristics that are found 37 statistically significant in preceding the upper quartile stocks Of the random samples. First, the market is sifted each year and all stocks having the investment character- istic deemed most significant in predicting high volatility are selected. A second sift is then performed on the stocks selected by the first sift with the result that the stocks selected possess the two most important investment characteristics that precede highly volatile stocks. The industrial common stocks listed on the NYSE having a year- end closing price of $30 per share or above are sifted each year as many times as there are significant invest- ment characteristics as determined in Step 1. The probabilities are good that the stocks making it through all the sifts in any one year will have high relative volatility the following year. It is on these stocks that straddle Options are purchased. Step 3. Purchase of Straddles. One six-month straddle option is purchased on the first trading day of each holding period (January, April, July, and October) on each stock selected and held until maturity when it is either exercised or allowed to expire. If the market price of the stock is below $30 or above $100 per share on any of the purchase dates, a straddle is not purchased at that time. But if the market price should close within the $30 to $100 range on any of the subsequent purchase dates, one would be purchased. A minimum of zero and a maximum of four straddles can be purchased each year on 38 each stock selected. In a strong bull market such as 1967 many of the market prices could advance beyond $100 per share whereas in a bear market such as 1969 many prices could fall below $30 per share. A stock split or large stock dividend could conceivably adjust the market price into or out Of the allowable price range. Price Range. A straddle will not be purchased on any stock selling under $30 per share because the cost is prohibitive. The Option premium expressed as a per cent of the cost Of 100 shares of the stock at the striking price decreases as the striking price increases. As shown in Tables 2-1 this per cent cost declines rapidly until the striking price reaches 530, then the rate of decline slows and becomes a constant at a striking price of $50. Information in Table 2-2, although not as precise, also verifies this fact. Likewise, a straddle will not be purchased on any stock selling above $100 per share. First, as shown in Table 2-2, there is not much option activity on these stocks either in straddles or puts and calls.8 Apparently, the willingness on the part Of writers or buyers to deal in options on high priced stock is lacking. Secondly, the costs are prohibitive in terms of 8The S.E.C. Report found only three puts and four calls written during the month of June, 1959, having a striking price above $100. Source: Security and Exchange Commission, op. cit., Table 30, p. 86. 39 Table 2-1 Conversion of Dadekian's Evaluation of Option Bids into Bids Expressed as a Per Cent of the Striking Price Bids to Straddle Striking ** Option Sellers* Price Percentile l90-Day Options ‘95-Day Options 10 25 26.0 13-0 50 27.0 19.5 75 28.0 20.5 20 25 21.0 15.0 50 22.0 16.0 75 24.0 17.0 30 25 17.5 13.0 50 19.0 14.5 75 21.0 16.0 50 18.0 14.0 75 19.5 15.0 so 25 15.5 12.0 so 17.0 13.5 75 19.0 14.5 so 17.0 13.0 75 19.0 14.5 70 25 15.5 11.5 50 17.0 13.0 75 19.0 14.5 Source: Zaven A. Dadekian, The Strategy of Puts and C lls-Sellin O tions for Maximum Profit With Minimum Risk, New York: Corinthian Editions, 1968 , pp. 98-103. Conversion performed by Zweig, Op. cit., p. 190. * Premium bids to option writers expressed as a per cent of the cost of 100 shares at the striking price. * *Bids for a stock with a given striking price are shown at three different percentile levels. The 25th percentile means that 25 per cent of the bids at a par- ticular striking price are below the corresponding bid listed in the table. The 50th and 75th percentiles mean that 50 and 75 per cent of the bids respectively are below the corresponding amounts in the table. 4O .moosmcoxm xooum cmoauoad Ono xuo» 3oz 0:9 so panama uxooum coasou so ncoaumo uncommon co mmma .ocsb Daemon nausea: ma Oo>fiouou nauseoum oomuo>¢a .4. .OOth omcsulpfls on» us mousse OOH mo pace on» mo ucoo mom a no anemone oumuo>m oneo 0 0m 0 Q .On manna ..H{Q_.md .coamnaaeou oocmgoxn use mowuwusuow ”common oz sso.~ N 02 omo.s H uo>o can oo.oosm o.ms mov.a m H.as ~oo.a o oo.mom ou oo.oom o.oa Hos.a ms «.Hs «on ma oo.opm o» oo.oom o.os mvo.s «a m.ss «mo «a oo.omm on oo.omm o.os moo - m.~a pom ma om.m¢o o» oo.o¢o m.os app on o.ms who o~ mo.omm on oo.om» m.o~ «am so o.vs own on oo.o~o o» oo.o~m «.mm Hon co ~.o~ non ha oo.oam on oo.osm Oz OON m 0 02 Nov w v oo.oam menu when ivnou Bfidflahm Oxuoum tvuOU Efldlflum QXUOHm OQMHU Dcou mom ounuo>¢ mo .02 0:00 mom oumuo>< mo .Oz ocean nsoau o ODOOXIO u=0wu o annotam ..ooaosuoo xooum mo oosuo so oosusoooau ncoaumo eavpmuum nucOSIme Ono nucozloouza so manusoum oomuo>¢ NIN OHQGB 41 the dollar consequences a buyer pays if the Option expires without being exercised. Since only one straddle Option per stock is purchased, the loss of the entire premium on a high priced stock more than Offsets the profits on a few lower priced stocks. Length of Option. Only six-month straddle Options are purchased because all evidence indicates they are more profitable relative to shorter term Options. All nine Of Zweig's buying strategies involving six-month Options had better returns than the corresponding three month strategy.9 In Zieg's study, investments in six-month options had superior returns over investments in 95-day Options.lo These results were also substantiated by the studies of Boness, Kruizenga and Katz. The explanation for this is that 90-day Options, while maturing in one-half the time of 6-month Options, are not one-half the price of 6-month Options; the premium in a 90-day option averages between 65-70 per cent of the premium on a 6-month premium all other things equal.11 Premium. The premiums on the straddle options are estimated at a constant twenty-three per cent Of the cost of 100 shares at the striking price. Table 2-1 shows that 9Zweig, Op. cit., Table 3-7, p. 113. 10Zieg, Op. cit., Tables 45-51, pp. 288-294. 11Securities and Exchange Commission, Op. cit., Table 29, p. 84. 42 at the 75th percentile on striking prices of $30 and above, 75 per cent of the bids to straddle Option sellers on 190- day options are below 19.5 per cent of the cost of 100 shares at the striking price. Because actual premiums paid to writers are usually a little above bid quotes, this figure was rounded to twenty per cent. To ascertain the buyer's premium, the dealer's markup must be added to the writer's premium. The S.E.C. Repgrt On Put and Call 027 .pippp_found that fifty-five per cent of the calls sold during June, 1959 had percentage markups of less than fifteen per cent and an average per cent markup of 14.8 per cent.12 Thus the writers percentage premium of twenty per cent is increased by fifteen per cent to arrive at the twenty-three per cent as the buyer's premium. For example, the writer's premium for selling a straddle Option on a stock having a striking price of $50 would be twenty per cent of the cost of 100 shares at $50 per share or $1000. The dealer's markup is fifteen per cent of $1000 or $150 which when added to the writer's premium means the buyer pays an $1150 premium. This is exactly twenty-three per cent of the cost of 100 shares at the striking price of $50 per share. Step 4. Rates of Return. Rates of return on in- vestment are calculated for each of the thirty-six periods 12Securities and Exchange Commission, Op. cit., Table 33, p. 92. 43 that straddles are purchased. The following assumptions and adjustments are made to get realistic results. Purchase Dates. It is assumed that straddle Opu tions are purchased on the first trading day of each period (January, April, July and October) beginning with the first period of 1962 and ending with the fourth period Of 1970. Striking Price. All straddles are assumed to have been purchased at striking prices which are equal to the closing prices of the stocks on the first trading day of each period, adjusted upward or downward to the nearest whole dollar. Holding Periods. It is assumed that all Options are held for a full six months and no part of it can be exercised in the interim; conceivably both the put and call sides of the straddles could be exercised but this very rarely happens. The assumption is realistic because the S.E.C. Report found that seventy-five per cent of call Options were exercised on their expiration date or less than a week before expiration and only about fifteen per cent were exercised more than thirty days before expiration.13 Tax Status. A tax-exempt position is assumed for the buyer in computing rates of return. Cash Dividends. The effect of a cash dividend is 13Securities and Exchange Commission, op. cit., p. 51. 44 to reduce the striking price of all outstanding put and call options by the amount of the dividend on the day the stock sells ex-dividend. A cash dividend benefits the holder of a call option because the price at which the stock can be purchased is reduced whereas it works against the put holder because the price at which he can sell is reduced. In other words, the benefits of a cash dividend go to the potential owner, buyer of a call Option or seller of a put option. All striking prices have been adjusted for cash dividends. Stock Dividends and Splits. A stock dividend or stock split reduces the striking price by means of the following formula: Old striking price New Striking Price = l + number of new shares per each old share The owner of a call Option with an original striking price of $50, after a 5 per cent stock dividend, would buy 105 shares for $5,000. The holder of a put Option will de- liver or sell 105 shares for $5,000. A stock split would have the following effect on the above situation. If the split was two-for-one, the new striking price is $25 and 200 shares are purchased or delivered instead of the 100 in the original contract. All striking prices have been adjusted for stock dividends and stock splits. Investment Base. It is assumed that the buyer 45 maintains no other position in the stock except for the rights associated with the straddle; no long or short positions are maintained. If the call side of the strad- dle is exercised, the stock purchased from the writer is immediately sold and if the put side is exercised, the stock sold to the writer is purchased at that time. There- fore the investment base assumed is simply 100 per cent of the cost Of each straddle option purchased. Brokerage Commissions. Since a cash-tO-cash port- folio is maintained, a roundtrip commission schedule is used. Instead of using the exact commission schedule of the NYSE, Zweig's abbreviated schedule shown in Table 2-3 is used.14 Table 2-3 Commission Schedule Stock Price* Roundtrip Commission Per 100 Shares Under $20 $ 50 $20 to $39 $ 75 $40 to $149 $100 $150 and above $150 * The stock price is based on the average of the striking price and the market price at the time of exercising. The exact one-way commission on 100 shares of a 14Zweig, Op, cit., Table 2-4, p. 63. 46 $50 stock would be $19 plus 1/10% of the money amount or $44. The exact roundtrip commission of $88 is closely approximated by the amount of $100 in the abbreviated schedule. Gross Proceeds. This is the difference between the adjusted striking price and the market price multi- plied by the number Of shares Optioned which is always one hundred unless a stock split or stock dividend is declared. If the market price at the date of exercising is above the adjusted striking price, the call side of the straddle is exercised and if the market price is below the adjusted striking price, the put side is exercised. If the gross proceeds in either case are not larger than the roundtrip commission, the Option is not exercised. Net Proceeds. Gross proceeds minus commissions equal net proceeds. If an Option is not exercised, net proceeds are zero. Profit or (Loss). Net proceeds minus the cost of the Option equals profit or (loss). If the net proceeds are larger than the cost, the transaction is profitable. If the Opposite is true, a loss is incurred. When an Option is not exercised, the loss equals the cost of the Option. gate of Return. The rate Of return on investment is computed by dividing total profit or (loss) by the total cost of the Options. Since the profit or (loss) 47 is realized exactly six months after purchasing the Op- tions, semi-annual rates of return are actually computed. A weighted-average annual rate of return is cal- culated by weighting each of the four semi-annual rates Of return by the proportion of the total annual cost ex- pended in each period. Step 5. Cogparison. The annual rates of return in this study are compared with Zweig's returns on those strategies involving the purchase of sixpmonth straddle Options.15 A comparison is also made with Zieg's returns from purchasing six-month straddle Options although our purchase and exercise dates do not coincide in all 16 As any portfolio manager would do, the annual periods. rates of return are compared with general market returns and the returns on high risk mutual funds. Risk comparisons are also made where risk is measured by the coefficient of variation, a relative measure of dispersion. If the annual rates of return generated by this strategy are higher with lower or equal risk or the returns are equal with lower risk, then the strategy is a success. ISZweig, Op. cit., Table 3-7, p. 113. 16Zieg, Op. cit., Table 54, p. 139. CHAPTER 3 ANALYSIS OF RESULTS Hypptheses Testing The first, second, third and sixth null hypotheses are rejected using the Wilcoxon matched-pairs test at a level Of significance of .01 and the following alternative hypotheses accepted. 1) Hi: The average volatility preceding upper quartile stocks is greater than the aver- age volatility preceding lower quartile stocks. 2) Hi: The average turnover preceding upper quartile stocks is greater than the aver- age turnover preceding lower quartile stocks. 3) Hi: The average number of shares outstanding preceding upper quartile stocks is less than the average number of shares out- standing preceding lower quartile stocks. 6) Hi: The average investment quality preceding upper quartile stocks is less than the average investment quality preceding lower quartile stocks. This means that highly volatile stocks are on the average preceded by higher volatility, higher turnover, lower number of shares outstanding and lower investment quality than lower volatile stocks. Table 3-1 shows the averages for each of these four investment variables. The average volatility preceding upper quartile 48 49 stocks is significantly larger each year than that pre- ceding the lower quartile stocks except one year, 1969, when the difference was only a positive .0701. Of the 100 upper quartile stocks, 64 are preceded by above average prior volatility whereas only 13 of the 100 lower quartile stocks are. Thus there is a significant relationship be- tween a stock's relative volatility one year and the following year, confirming the study mentioned in Chapter 2.1 In selecting stocks, one Of criterion will be the prior year's volatility. Likewise, the average turnover preceding upper quartile stocks is significantly larger than that pre- ceding lower quartile stocks in each Of the ten years. Annual prior turnover ratios of greater than .3300 pre- cede 55 of the 100 upper quartile stocks versus only 3 of the 100 lower quartile stocks. This substantiates the conclusion reached by Heins and Allison that high turnover causes volatility, so it will be another criterion for selecting highly volatile stocks.2 The average number Of shares outstanding preceding the upper quartile is significantly smaller than that preceding the lower quartile stocks in eight of the ten years. Using 10 million shares as an arbitrary cut-Off lPratt, op. cit. 2Heins and Allison, Op. cit. 50 Table 3-1 Prior Year's Investment Characteristics of Upper and Lower Quartile Stocks Average Volatility Average Turnover Year Upper Lower Upper Lower 1961 .5078 .3530 .4434 .0754 1962 .6447 .3262 .3661 .0989 1963 .6315 .4534 .5317 .1185 1964 .4213 .2570 .4977 .1300 1965 .4174 .2440 .3606 .0804 1966 .8152 .3221 1.3914 .1216 1967 .5966 .3351 .5890 .1098 1968 .8416 .4189 1.0015 .1653 1969 .4749 .4048 .4175 .1667 1970 .4509 .2824 .3553 .1360 Average Shares Average Outstanding (000's) Investment Rating* Year Upper Lower Upper Lower 1961 2,399 9,785 4.6 3.4 1962 4,351 12,350 4.4 3.4 1963 4,118 5,433 4.4 3.1 1964 1,879 11,047 4.7 3.0 1965 6,626 15,481 4.5 2.6 1966 3,308 23,938 4.5 3.2 1967 4,478 17,071 4.8 3.1 1968 5,802 17,705 4.8 2.8 1969 15,085 16,833 3.7 3.2 1970 10,633 24,275 4.0 2.8 *These numerical ratings are inversely related to investment quality: the higher the quality, the lower the numerical rating and vice versa. point, only 14 of the upper quartile stocks have a greater number of shares outstanding versus 51 of the lower quar- tile stocks. This confirms the idea that the number of shares outstanding and volatility are inversely related 51 and thus becomes the third selection criterion. Finally, the upper quartile stocks are on the average of lower investment quality (higher numerical rating) than the lower quartile stocks again confirming the findings of Heins and Allison.3 The investment ratings of the lower quartile stocks average about 3 which is a B+ while the upper quartile stocks average approxi- mately 4.5 which is between a B and C+. Whereas 87 per cent of the upper quartile stocks have an investment quality rating of B or less, 65 per cent Of the lower quartile stocks have an investment rating of B+ or better. Investment quality becomes the fourth selection criterion.4 The other four null hypotheses are all accepted at a level of significance of .01, meaning that there is not a significant difference between the average price/earning ratio, dividend yield, percentage move and absolute price preceding upper quartile stocks and lower quartile stocks. Selection Process In a sample selection process, the four criteria established above are applied to the upper and lower quartile stocks as follows: 1) Prior year's volatility must be above average for that year. Ibid. Ibld. 52 2) Prior year's annual turnover must be greater than .3300. 3) Number of shares outstanding at the end of the prior year must be below 10 million. 4) Investment quality rating must be B or less; numerical rating must be 4 or higher. The results of this sample selection process are quite significant: 45 per cent of the upper quartile (highly volatile) stocks are selected versus only 2 per cent of the lower quartile stocks. This selection process Obvi- ously improves the probabilities of choosing stocks ex- hibiting high relative volatility and should work well in selecting stocks on which to purchase straddle Options. These criteria are modified slightly and applied to all industrial common stocks listed on the NYSE having a year-end closing price of $30 per share or above. Any stock having a year-end closing price below $30 per share but rising above that amount later in the following year would still not be eligible for selection. Stocks with year-end closing prices above $100 per share are eligible for selection even though straddles will not be purchased on them unless the stock closes below $100 per share on any subsequent purchase date. The procedure for selecting stocks uses both relative and absolute criteria. As shown in Table 3-2, volatility and turnover are relative criteria while number of shares outstanding and investment quality are absolute 53 Table 3- 2 Selection Criteria Applied to Eligible Stocks . Maximum Maximum Minimum Minimum Number of Investment Year Turnover Volatility Shares Out. Quality 1961 .5000 .500 15 Million B 1962 .4800 .500 15 Million B 1963 .5000 .500 15 Million B 1964 .5000 .500 15 Million B 1965 .6000 .600 15 Million B 1966 .6000 .600 15 Million B 1967 .8000 .800 15 Million B 1968 .7000 .700 15 Million B 1969 .5000 .500 15 Million B criteria. The first step is to select the stocks having above average turnover ratios. Obviously, this ratio will vary from year to year, depending on market conditions. Since turnover ratios on the average were much higher in 1967 than in 1962, a higher ratio was required in the former year than the latter in the selection process. The next step is to select from the stocks having above average turnover ratios, those that also have shown above average price volatility that year. This again is a relative measure, depending on the volatility of the market, but a minimum requirement of .500 is imposed which is adjusted upwards in highly volatile years such as 1965 thru 1968. A certain minimum amount of volatility is required to make straddle buying profitable regardless of its relative standing. Purchasing straddles on a stock 54 having a volatility ratio of .400 would not be profitable even if this is high on a relative basis, while purchasing straddles on a stock having a volatility measure of .700 would probably be profitable regardless of its relative standing. Finally, all the stocks having less than 15 million shares outstanding and an investment quality of B or less are further selected from those passing the first two selection criteria. Table 3-3 shows the number of eligible stocks and the number actually selected each year. Table 3-3 Number Of Eligible Stocks and Actual Selections Number of Number Actually Year Eligible Stocks Selected 1961 394 28 1962 315 21 1963 354 23 1964 392 22 1965 490 30 1966 392 31 1967 568 35 1968 689 28 1969 411 27 Purchase of Straddles Straddle Options are purchased on the first trading day of each period in the year following a stock's selec- tion if the price on the purchase date is within the allowable price range, $30 to $100. For example, straddles 55 are purchased during 1962 on the stocks selected using 1961 year-end measures of turnover, volatility, shares out- standing, investment quality and closing price. This pro- cess begins with the first period (January) of 1962 and ends with the last period (October) of 1970. Table 3-4 shows the number of straddle Options purchased at the beginning Of each period and the year. Table 3-4 No. of Straddles Purchased Each Period Year First Second Third Fourth Total 1962 27 21 ll 10 69 1963 18 17 18 17 70 1964 21 l9 16 13 69 1965 22 21 l8 17 78 1966 27 21 23 23 94 1967 26 23 23 23 95 1968 28 28 28 27 111 1969 27 17 8 4 56 1970 27 17 8 12 64 The number Of stocks selected at the end of one year and the number of Options purchased at the beginning of the first period the following year (at most three days later) are not always equal for Obvious reasons. A stock selling above $100 per share is eligible for selec- tion, but a straddle can't be purchased until the price falls below $100 on a subsequent purchase date. However, on the bottom side the same minimum requirement, $30 per share, applies to both selection of stocks and purchase of 56 straddles on stocks selected. The dollar investment required to purchase these Options is shown in Table 3-5. Table 3-5 3 Investment in Options by Period and Year Year First Second Third Fourth Total 1962 $ 28,199 $ 21,523 $ 10,166 $ 9,951 $ 69,839 1963 19,479 19,907 20,181 19,688 79,255 1964 24,946 24,142 18,525 14,610 82,223 1965 22,788 24,543 20,236 22,422 89,989 1966 35,013 30,128 31,532 27,070 123,743 1967 31,900 30,023 32,652 33,318 127,893 1968 35,107 31,951 35,569 33,410 136,037 1969 31,573 17,220 7,095 5,016 60,904 1970 30,269 21,446 8,496 13,140 73,351 Total $259,274 $220,883 $184,452 $178,625 $843,234 Actually, the amounts in the total column are not required because the net proceeds received on straddles purchased two periods earlier can be applied to the current period purchases. For example, the net proceeds from the first period purchases are realized at the beginning of the third period and applied to the cost of straddles purchased at that time. An initial investment of $50,000 to cover the first two periods plus an additional $5,000 in 1964 would have been sufficient to cover all purchases. Returns on Investment Table 3-6 shows the net proceeds generated on each periodical investment. These amounts are related back to 57 Table 3-6 Net Proceeds Per Period Year First Second Third Fourth Total 1962 $37,383 $26,478 $ 10,492 $ 9,731 $ 84,084 1963 14,818 20,896 13,755 22,530 71,999 1964 28,800 19,421 12,855 11,075 72,181. 1965 15,768 25,571 52,678 49,829 143,846 1966 37,279 32,352 20,002 48,775 138,408 1967 65,573 37,769 38,184 30,396 171,922 1968 28,545 41,996 24,805 23,498 118,844 1969 50,911 24,740 5,314 6,753 87,718 1970 54,482 30,565 8,731 9,645 103,423 the beginning of the period the investment was made and not to when the proceeds are actually realized, which is always six months later. Table 3-7 shows the profit or loss on each period. ical investment, again referring to the beginning of the period when the investment was made and not when proceeds were received. periodical investment. Table 3-8 shows the rate of return earned on each Since all Options are held for a six month time period, each return is a semi-annual rate of return. annual rates is shown in Table 3-9. Conversion Of these semi-annual rates of return to Average annual rates of return are positive in six years and negative in the other three, resulting in an average annual rate of return of 39.5 per cent over the nine year period. What is more encouraging is the fact Table 3-7 Profit (Loss) Per Period Year First Second Third Fourth Total 1962 $ 9,184 $ 4,955 326 $ (220) $ 14,245 1963 (4,661) 989 (6,426) 2,842 (7,256) 1964 3,854 (4,721) (5,640) (3,535) (10,042) 1965 (7,020) 1,028 32,442 27,407 53,857 1966 2,266 2,224 (11,530) 21,705 14,665 1967 33,673 7,746 5,532 (2,922) 44,029 1968 (6,562) 10,045 (10,764) (9,912) (17,193) 1969 19,338 7,520 (1,781) 1,737 26,814 1970 24,213 9,119 235 (3,495) 30,072 Total $74,285 $38,905 $ 2,394 $33,607 $149,191 Table 3-8 Rate of Return Per Period . Weighted Year First Second Third Fourth Average* 1963 -23e9 5.0 ‘31e8 1404 -9e2 1965 -30.8 4.2 160.3 122.2 59.9 1967 105.6 25.8 16.9 -8.8 34.4 1968 -18.7 31.4 -30.2 -29.7 -12.6 1969 61.3 43.7 -25.l 34.6 44.0 Average 19.7 tion Of the annual amount involved each period. * Returns each quarter are weighted by the prOpor- As an example, it would not be fair to equate the returns earned on the first and fourth period investment of 1962 because the first period investment is three times more than the fourth period investment. 59 Table 3-9 Rate of Return Per Period Restated on Annual Basis Year First Second Third Fourth Weighted Average* 1962 65.2 46.0 6.4 -404 40.8 1964 31.0 -39.2 -61.0 -48.4 —24.4 1965 -61.6 8.4 320.6 244.4 119.8 1967 211.2 51.6 33.8 -l7.6 68.8 1968 -37.4 62.8 -60.4 -59.4 -25.2 1969 122.6 87.4 —50.2 69.2 88.0 1970 160.0 95.0 5.6 ~53.2 82.0 Average 39.5 that only one year in the last six (1965-1970) has been unprofitable, that being 1968. Because the market has been more volatile since 1965 than before, these results support the basic premise of this paper. There are thirty-six possible six-month holding periods and rates of return are positive in twenty-two periods and negative in the other fourteen. The six years having positive average rates of return have common pat- terns: each experienced exactly one unprofitable holding period and three profitable ones. The three years having negative returns experienced either two or three unprofit- able holding periods. A form of sensitivity analysis is performed to determine if the above investment results can be improved. One type Of analysis makes all the selection criteria 60 more restrictive each year than that listed in Table 3-2. Each year's minimum turnover and volatility ratio is in- creased by .100 and the maximum number of shares outstand- ing and investment quality is reduced to ten million shares and a C+ respectively. The average rate of return on in- vestment using the more restrictive criteria is not significantly different from that using the original criteria. The selection criteria are then made even more restrictive by increasing each year's minimum turnover and volatility by .200 and reducing the maximum number of shares outstanding and investment quality to five million and a C+ respectively. Again the results are not signif- icantly different. A second type of analysis makes only one selection criteria more restrictive while the other three remain at the levels listed in Table 3-2. For example, the minimum turnover ratio is increased each year while volatility, the number of shares outstanding and investment quality are not changed. This process is repeated for the other criteria but in all cases, the results are not signifi- cantly different from those appearing in Table 3-8. Table 3-10 is used to facilitate the analysis of these period returns except for those periods when move- ments in the Dowaones Industrial Average do not coincide with or represent movements in the type of stocks on which straddles are purchased. The fourth period of 1965 is a 61 Table 3-10 Dow-Jones Industrial Average Percentage Moves* Year First Second Third Fourth Average** 1962 -23.2 -18.1 +10.5 +17.9 17.4 1963 +8.4 +7.4 +8.0 +6.9 7.7 1964 +9.0 +7.6 +5.1 +1.6 5.7 1965 -0.7 +4.7 +ll.7 -0.6 4.4 1966 -10.2 -l6.3 -9.7 +11.9 12.0 1968 -0.8 +1l.3 +5.1 -0.0 4.3 1969 -7.5 -13.1 -8.3 -3.4 8.1 1970 -14.6 -3.2 +23.l +18.9 15.0 *Percentage moves are calculated over six month time periods, from the beginning of one quarter to the beginning of the third subsequent quarter. **Absolute average of the quarterly percentage figures. good example of the two groups not moving together; the Dowaones Industrial Average was almost constant, falling only six points, while in the same period, many of the glamor and speculative stocks continued to advance sharply and peaked out much later in 1966. Table 3-11 ranks the average annual Dowaones In- dustrial Average price movements by absolute size and av- erage annual rates of return on a scale from highest to lowest. The only years when the rankings are far apart are 1962 and 1965. Both are years in which the Dow-Jones Industrial Average was not representative of the type of stocks straddles were purchased on. 1962 was a bear market 62 Table 3-11 Rankings Of Average Percentage Moves and Annual Rates of Return Average Annual Year Percentage Moves* Rates of Return** 1962 1 5 1963 6 9 1964 7 8 1965 8 l 1966 3 6 1967 5 4 1968 9 7 1969 4 2 1970 2 3 *From Table 3-10. are From Table 3-9. year in which the Dow-Jones Industrial Average recovered in the third and fourth quarters but other stocks did not. The Dow-Jones Industrial Average peaked out in 1965 but other issues continued to advance sharply until later in 1966. Tables 3-12 and 3-13 rank the absolute percentage movements of Table 3-10 and the rates of returns in Table 3-8 respectively. A comparison of the ranks for each of the thirty-six periods reveals that in twelve periods, the rankings are within adjacent quartiles. Only eight periods have rankings which are separated by one or more quartiles and five Of these occur in 1969 and 1970. In the first and fourth holdings periods of 1969, 63 Table 3-12 Rankings of D-J IA Percentage Movements Year First Second Third Fourth 1962 l 4 12 5 1963 18 23 20 25 1964 17 21 20 32 1965 34 29 10 35 1966 13 6 14 9 1967 15 24 26 16 1968 33 11 28 36 1969 22 8 19 30 1970 7 31 2 3 Table 3-13 Rankings of Rates of Return Per'Period Year First Second Third Fourth 1962 10 13 21 23 1963 27 19 35 16 1964 15 26 27 28 1965 34 20 l 2 1966 18 17 36 4 1967 3 12 14 24 1968 . 25 11 32 31 1969 6 7 29 9 1970 S 8 22 30 the Dow-Jones Industrial Average fell 7.5 per cent (rank of 22) and 3.4 per cent (rank of 30) respectively while the rates of return rank 6 and 9 respectively. The stock market peaked in December, 1968 and started its decline, gradually at first and more rapidly later in the year. Meanwhile, the stocks on which straddles were purchased, 64 the glamor and speculative stocks, fell much more dras- tically which explains the high returns for this period. Since only four straddles are purchased in the fourth quarter of 1969, this period is not very significant in the analysis. The rankings in the second, third and fourth periods of 1970 also differ by one or more quartiles. In the second period, the Dowaones Industrial Average fell gradually (rank of 31) while the glamor and speculative stocks continued their rapid decline which explains the high rate of return (rank of 8). In the third and fourth periods, the DowaJones Industrial Average recovered and advanced rapidly (ranks of 2 and 3 respectively) while the glamor and speculative stocks did not yet turn-around which explains the poor returns in those periods (ranks of 22 and 30 respectively). The three other periods having wide differences intheir rankings are the fourth period of 1962, the fourth period of 1965 and the third period of 1966. The fourth period of 1962 saw a rapid recovery from the bear market break by the Dowaones Industrial Average (rank of 5) which the glamor and speculative stocks didn't participate in, resulting in a poor return (rank of 23). As mentioned previously, the fourth period of 1965 saw the Dowaones Industrial Average lie dormant (rank of 35) while the glamor and speculative stocks continued to advance, re- sulting in a high rate of return (rank Of 2). The third 65 period of 1966 included the famous “credit crunch” and entailed a Dowaones Industrial Average decline of 9.7 per cent (rank of 14). Apparently the glamor and specu- lative stocks fell rapidly and then recovered just as rapidly in the six-month period, resulting in a negative rate of return (rank of 36). Returns in all other periods are adequately ex- plained by movements in the Dowaones Industrial Average which is representative of movements in straddle Option type stocks. Since the direction of price change is unimportant and the fixed expenses to be covered are relatively small, a relatively large number of straddle Options should be exercised either on the call side or put side. This is confirmed by Tables 3-14 and 3-15 which show that more than ninety per cent of all straddles purchased are exercised in twenty-seven periods whereas less than ninety per cent are exercised in only nine periods. There are only three periods having more than two unexercised options: the second period of 1965 and the third and fourth periods of 1968. All three periods either coincide with a market peak or are close to a market peak: such periods are usually characterized by many cross currents in the market caused by uncertainty. Some stocks start to decline before the peak, others continue to advance after the peak and unfortunately for straddle buyers, some are stationary which means that the price 66 Table 3-14 Number of Straddle Options Exercised Eactheriod Year First Second Third Fourth Total 1962 26 20 11 10 1963 16 16 16 16 21 1964 21 18 14 ll 64 1965 21 18 18 17 74 1966 25 19 22 22 88 1967 25 22 23 22 92 1968 27 26 23 24 100 1969 26 17 7 3 53 1970 26 16 8 12 62 Table 3-15 Percentage of Straddle Options Exercised Each Period* Year First Second Third Fourth Total 1962 96.3 95.3 100.0 100.0 97.1 1963 88.9 94.1 88.9 94.1 91.4 1964 100.0 94.7 87.5 84.6 92.7 1965 95.5 85.7 100.0 100.0 94.9 1966 92.6 90.4 95.7 95.7 93.6 1967 96.2 95.7 100.0 95.7 96.8 1968 96.4 92.9 82.1 88.9 90.1 1969 96.3 100.0 87.5 75.0 94.6 1970 96.3 94.1 100.0 100.0 96.9 *Calculated from Tables 3-10 and 3-14. movement is not sufficient to cover roundtrip commissions. A more relevant question is not how many options are exercised, but how many are exercised profitably versus unprofitably which is illustrated by Tables 3-16 and 3—17. 67 Table 3-16 Number of Options Exercised at a Profit Each Period Year First Second Third Fourth Total 1962 18 14 5 4 41 1963 4 5 5 7 21 1964 ll 6 3 4 24 1965 7 10 16 15 48 1966 12 11 7 19 49 1967 16 12 9 10 47 1968 10 13 7 5 35 1969 21 12 2 2 37 1970 22 9 4 4 39 Table 3-17 Number of Options Exercised at a Loss Each Period Year First Second Third Fourth Total 1962 8 6 6 6 26 1963 12 11 11 9 43 1964 10 12 11 7 40 1965 14 8 2 2 26 1966 13 8 15 3 39 1967 9 10 14 12 45 1968 17 13 16 19 65 1969 5 S 5 2 17 1970 4 7 4 8 23 As expected, the years showing positive rates of return have more Options exercised at a profit than at a loss while the years of negative returns show just the opposite. In fact, the negative return years have nearly twice as many Options exercised unprofitably as profitably. More Options are exercised profitably in fourteen 68 periods, more unprofitably in nineteen periods and three periods are even. Positive rates of return are earned in all fourteen periods having a surplus of profitable Options, in five of the nineteen periods having more un— profitable Options and in all three of the periods having an even distribution. Apparently, the average profit per option exercised is larger than the average loss per option exercised which explains why the five periods having more unprofitable Options and the three even periods show pos- itive rates of return. Tables 3-18 and 3-19 illustrate the number of straddles exercised on the call and put side each period. More calls than puts are exercised in twenty-one periods, more puts than call inthirteen periods, and two periods have an equal number exercised. Which side dominates in any period will Obviously depend to a great extent on the movement Of the general market that period. Calls dominate in seventeen upward moving periods and four downward moving periods but in three of the four downward moving markets, the decline is less than one per cent. Conversely, puts dominate in eleven downward moving periods and only slightly in two upward moving periods. The two periods having an equal distribution of puts and calls include one upward and one downward moving period. Another important question is which side, put or call, contributes the most to profits or losses? In the 69 nine periods having the highest returns, the exercization of calls dominate four periods and puts five periods but one only slightly. In the nine periods having the worst returns, calls dominate five periods, puts three and one is even. SO it appears that puts and calls can contribute equally to profits and losses. Table 3-18 Number Of Options Exercised on the Call Side Year First Second Third Fourth Total 1962 0 2 9 8 19 1963 ll 12 10 ll 44 1964 12 12 6 10 40 1965 16 13 17 17 63 1966 21 4 ll 20 56 1967 22 19 ll 5 57 1968 17 22 14 6 59 1969 3 l 2 l 7 1970 2 4 4 ll 21 Table 3-19 Number of Options Exercised on the Put Side Year First Second Third Fourth Total 1962 26 18 2 2 48 1963 5 4 6 5 20 1964 9 6 8 1 24 1965 S 5 1 0 11 1966 4 15 ll 2 32 1967 3 3 12 17 35 1968 10 4 9 18 41 1969 23 16 5 2 46 1970 24 12 4 l 41 CHAPTER 4 COMPARISON OF RESULTS The most meaningful comparison of this study's results should be with other empirical studies involving the purchase of sixpmonth straddle Options. Since this would narrow the comparison to only two studies, Zieg's and Zweig's, the general market indexes and mutual fund performance are also used for comparative purposes. Zieg's Results. As mentioned previously, he pur- chased and sold 2,212 options under the terms called for on actual bid sheets received at six different three-day time periods from September, 1965 to January, 1967. Each time period supposedly represents a different type of market, the first starting just before a bull market peak and the last type ending after a bear market bottom. The information pertaining only to the purchase of six-month straddle Options is summarized in Table 4-1. The semi-annual rates of return on investments made in the period which most closely approximates his holding dates are used to make direct comparisons. Three of these periods are good approximations of his holding periods while the other three are not. The first market type, represented by September 70 71 Table 4-1 Investment, Net Profit and Rate of Return By Market Type Market Type Date Investment Net Profit Rate of Return Top-Turn Around 1 9-65 $102,761 $50,806 49.4% Top-Down 2 2-66 135,576 72,426 53.4 Down 3 4-66 66,102 68,290 103.3 Bottom Turn Around 4 5-66 79,419 29,553 37.2 Bottom-up 5 10-66 37,000 45,838 123.9 Up 6 1-67 29,487 20,469 69.4 Average 72.7 Source: Zieg, Op. cit.; Tables 50-51, pp. 293-94. 23, 26, and 27, 1965, is closely approximated time wise by the fourth period Of 1965 which starts October 1. Table 4-2 shows that the return of 122.2 per cent for this period is more than twice as large as his return of 49.4 per cent. Since the market did not change significantly in this one week difference, the superior results of this study must be attributed to the selection procedure used. The second market type, represented by February 8, 9, and 10, 1966, is approximated, but not closely, by the first holding period of 1966 which began more than one month earlier on January 3. This big difference in pur- chase and exercise dates explains his return of 53.4 per cent versus 6.5 per cent in this study. His dates allow him to purchase straddles at the absolute high point of 72 the bull market (D-J I A closed at 995.15 on February 9) and to exercise after a drastic market decline of almost 100 D-J I A points in July and part of August, 1966. The Dowaones Industrial Average fell over 200 points during his holding period, 995.15 on February 9 to 792.03 on August 20, while the decline was less than 100 D-J I A points for this holding period, 968.54 on January 3 to 877.06 on July 1. This accounts for the large difference in returns by the two studies. Table 4-2 Comparison of Semi-Annual Rates of Return Market Type Date Zieg's Study This Study** Top-Turn- Around 1 9-65 49.4% 122.2% TOp-Down 2 2-66 53.4 6.5 Down 3 4-66 103.3 7.4 Bottom-Turn- Around 4 5-66 37.2 -36.6 Bottom-up 5 10-66 123.9 80.2 Up . 6 1-67 69.4 105.6 Average 72.7 47.6 Coeff. of Variation .466 1.343 *From Table 4—1. ** From Table 3-8. The third market type, represented by April 20, 21 and 22, 1966, is best approximated by the second period of 1966 which starts three weeks earlier on April 1. His 73 return of 103.3 per cent is much larger than the 7.4 per cent return earned in this study which again can be par- tially explained by the difference in purchase and exer- cise dates. The Dow-Jones Industrial Average is 20 points higher on his purchase dates and his exercise dates fall right after the peak of the liquidity crisis in October, 1966, a period of sharp declines in stock prices, especial- ly for glamor.and speculative stocks. Zieg's fourth market type, represented by May 23, 24, and 25, 1966 is compared with the third period Of this study although it began more than one month later on July 1. The -36.6 per cent return in this period does not even come close to his return of 37.2 per cent. The explanation for this large difference in re- turns can not be found in the Dowaones Industrial Averages which are relatively similar for both purchase and exer- cise dates. A possible explanation can be found in the movement of the American Stock Exchange Index which is more favorable during his holding period (16.8 in May to 13.2 in NOvember) than this study's (15.7 in July to 15.8 in January). Since a large number of his straddles are on American Stock Exchange stocks, this could partially account for his superior results. The fifth market type, represented by October 6, 7, and 10, 1966, is closely approximated by the fourth period Of 1966 which starts on October 3. The return of 80.2 per cent compares favorably with his return of 123.9 per cent 74 considering that his purchase dates are at the extreme bottom of the bear market (D-J I A was 744.32) and his exercise dates are two weeks later, a period in which the market advanced 20 D-J I A points. Finally, the sixth market type, represented by January 11, 12 and 13, 1967, is closely approximated by the first period of 1967. This return of 105.6 per cent is considerably larger than his return of 69.4 per cent and must be attributed to the selection procedure used. In summary, the average rate of return of 72.7 per cent in Zieg's study is larger than the average of 47.6 per cent in this study. However, differences in purchase and exercise dates are undoubtedly responsible for part of his larger returns, especially for the second and third market types. In the three periods having similar purchase and exercise dates, the returns in the study are larger in two periods and comparable in the other. Another factor which could account for his larger average return is the type of stocks on which straddles are purchased. Many Of the stocks involved in his study were listed on the American Stock Exchange whereas this study restricts purchases to NYSE listed stocks. Since the American Stock Exchange was more volatile over this time period, this probably improved his returns. Zweig's Results. He selected ten stocks randomly from each of three volatility classes each year and wrote and purchased Options monthly on each stock selected. His 75 study began in mid-1961 and ended in mid-1968, resulting in 2,520 hypothetical six-month straddle purchases. The pertinent information from this study is summarized in Table 4-3. Table 4-3 Annual Rates of Return on Investment to Buyers of Six-Month Straddles Volatility Class Year Low Medium High 61-62 4.70 -8.80 -13.70 62-63 -26.50 -77.70 74.90 63-64 -51.00 -26.10 24.00 65-66 -7.60 68.10 100.00 7 Year Average -37.81 -3.97 47.64 Source: Zweig, Op. cit., Table 3-7, p. 113. Zweig uses the premium as a per cent of the striking price to classify stocks by volatility class, making the assumption that the premium is highly correlated with price volatility. If the premium is below 14.5 per cent, the stock is placed in the low volatility class; if it is between 15.0 and 22.5 per cent, it is in the medium volatility class; and above 23.0 per cent, it is in the high volatility class. The result of this stratification method is a low 76 volatility class comprised of "blue chips” and a high volatility class comprised mainly of stocks not traded on the New York Stock Exchange. Therefore the most meaning- ful comparison is with the medium volatility class which includes many Of the same stocks as this study. In order to make a direct comparison, the annual rates Of return for this study had to be recalculated on a mid-year to mid-year time basis. Table 4—4 shows these returns and Zweig's returns on the medium volatility stocks. In comparison, the returns in this study are superior in four years, comparable in two years and in- ferior in only one year. Table 4-4 Comparison of Annualized Rates of Return Year This Study Zweig's Study 1961-62 55.6* - 8.80 1962-63 -6.0 -77.70 1963-64 -S.0 -26.10 1964-65 —18.8 2.20 1965-66 59.7 68.10 1966-67 42.8 55.40 1967-68 4.6 -40.90 Average 19.0 -3.97 Coeff. of Variation 1.72 13.04 *Includes only the six months of 1962. It appears that purchasing straddles on a monthly basis, as Zweig does, results in more volatile returns. 77 His negative returns are more negative in 1962-63 and 1963- 64 and positive returns slightly more positive in 1965-66 and 1966-67. This is.a logical consequence to purchasing on a monthly basis, because if price volatility remains low for a year, the more straddles purchased the greater the losses. Likewise, if a stock has high volatility, the more straddles purchased the greater the profits. Zweig's results are a better test for comparative purposes than Zieg's for three reasons. First, the time period is much longer, seven years versus twenty-one months, and more representative of normal market conditions. Zieg's time period includes a bull market high, a bear market which lasts only eight months and a full recovery, all in twenty-one months. Most twenty-one month market periods have not been this volatile. Second, the stocks in Zweig's medium volatility class each year include many of the same stocks selected in this study whereas Zieg's study includes many ASE and O-T-C stocks which were relatively more volatile during his time period than the NYSE stocks. And third, Zweig's stocks are selected randomly each year from the bid sheets of the largest option broker and dealer in the country, while Zieg's stocks are those mentioned on the bid sheets received by the Chicago office of one brokerage firm. By this comparison, the selection procedure used in this study is very effective. The average annual rate 78 rate Of return is much larger and risk, as measured by the coefficient of variation, is much lower. General Market Performance: The short-term goal of many a portfolio manager is to outperform the market using either the Dowaones Industrial Average or Standard and Poor's Index as the standard of comparison. Likewise, the performance of the straddle portfolios in this study will be compared with market performance to judge the effective- ness of this selection procedure. Table 4-5 shows the comparison with the annual rates Of return for the Dow-Jones Industrial Average and Standard and Poor's Index of 500 Stocks computed by the following formula: Annual change in market value + annual dividends Annual Rate of Return 2 Beginning of year value a Capital Gains Return + Dividend Return As expected, the average annual rate of return in this study is much larger than either the Domeones Indus- trial Average or Standard and Poor's 500 Stock Index. What is not expected is the smaller coefficient of varia- tion relative to that of the D-J I A and S a P 500 Stock Index. Considering the fact that most mutual funds and individuals do not outperform the averages, the selection procedure in this study would have to be deemed a success. 79 Table 4-5 Comparison of Annual Rates of Return With Market Returns Year This Study D-J I A S & P 500 1962 40.8 -7.62 -8.82 1963 -18.4 20.59 22.50 1964 -24.4 18.66 16.30 1965 119.8 14.15 12.27 1967 68.8 19.04 23.73 1969 88.0 -ll.60 -8.32 1970 82.0 9.06 +3.20 Average 39.5 6.04 6.86 Coeff. Of Var. 1.368 2.331 1.955 Mutual Fund Performance: The performance Of these straddle option portfolios should logically be compared with the performance of funds of a similar risk, meaning funds that actually trade in Options, warrants and other highly leveraged investment.vehicles. Some of the private hedge funds would make good comparisons but unfortunately, their performance results are not published. The next best alternative would be those mutual funds that are classified as growth funds and have the objective of max- imizing capital gains. This group is comprised mainly of the so-called “go'go funds or performance funds”, noted for their high-risk, high-return investment philosophy. Table 4-6 compares the average annual returns available on two of these groups with the returns from 80 this study. The return on a particular fund is measured by the percentage change in net asset value per share with capital gains (reinvested) plus dividend income (received in cash). The returns on all funds in a group are aver- aged each year to obtain an annual average rate of return per group. Table 4-6 Comparison of Annual Rates Of Return With Mutual Fund Performance Growth Funds Year This Study Smaller Larger* 1962 40.8 ~19.4 -18.1 1963 -l8.4 +20.3 +22.5 1964 -24.4 +11.6 +15.0 1965 119.8 +35.3 +32.4 1967 68.8 +58.3 +39.l Average 39.5 +10.28 +9.18 Coeff. of Var. 1.368 2.572 2.156 Source: Investment Companies 1970, (New York: Wiesenberger Financial Services, 1970 , pp. 122-127. *Includes only those funds with total assets greater than $300,000,000. The average annual rate Of return is approximately four times larger than the average of either the smaller or larger growth funds. The coefficient of variation is less, meaning that this investment strategy is effective 81 and successful in generating superior returns on the av- erage with less risk. Table 4-6 also points out the high negative correl- ation between the returns generated by this strategy and mutual fund returns. In the four years when mutual funds returns are negative, the rates of return using this strategy are all positive. Conversely, in the three nega- tive return years using this strategy, the mutual fund returns are positive. In only two of the nine years are the returns related. Summarizing the overall results, this investment strategy quite handily outperformed the general market, growth orientated mutual funds and a random selection procedure. It did not surpass Zieg's results mainly be- cause Of the time differences and type of stock differ- ences. Based on these comparisons, it is a viable and effective investment strategy which can be expected to generate profitable returns in the future as long as the market continues under the influence of institutional investors and remains volatile. CHAPTER 5 SUMMARY, QUALIFICATIONS AND IMPLICATIONS Summa The purpose of this study was to develOp and test the results of an investment strategy that would take advantage of increasing price volatility in the stock market. 1. The first step was to find the investment characteristics that are statistically significant in pre- dicting annual price volatility. A systematic random sample of forty stocks was drawn at the end of each year and divided into quartiles based on volatility. Eight types of investment information for the year preceding each sample year were collected on the upper and lower quartile stocks and averaged. The Wilcoxon matched-pairs test was used to test the hypothesis of a significant directional difference between the average investment characteristics preceding the upper and lower quartile stocks. The results showed that upper quartile stocks (highly volatile) were on the average preceded by higher volatility, higher turnover, lower number of shares out- standing and lower investment quality than the lower quartile stocks. 82 83 2. The second step was to select the stocks on which straddles are to be purchased which was accomplished by sifting the market each year. The first sift selected the stocks having above average turnover ratios. The second sift selected from the stocks having above average turnover ratios, those also possessing above average vola- tility ratios. Both turnover and volatility are relative criteria, dependent on other stocks that year. The third and fourth sifts were carried out simultaneously and sel- ected all stocks having less than 15 million shares out- standing and an investment quality of B or less from those passing the first two sifts. This resulted in a high of thirty-five and a low of twenty-one stocks selected each year with an average of approximately twenty-seven. 3. In step three, six-month straddle options were purchased on the first trading day of each period on all stocks selected if the market price was within the $30 to $100 range. The premium as a per cent of the striking price is too expensive on stocks selling under $30 per share and there is not much option activity in stocks selling above $100 per share. Only six-month straddle Options were purchased because all evidence indicates they are more profitable relative to shorter-term Options. The premiums on the straddle Options were estim- ated at a constant twenty-three per cent of the cost of 100 shares at the striking price. This amount was justi- fied by past empirical studies on option premiums. 84 4. Rates Of return were calculated in the fourth step with adjustments made for dividends, stock splits and commissions. It was further assumed that all straddles were held for a full six-months and the investor enjoyed a tax-exempt position. Average annual rates of return were positive in six years and negative in the other three, resulting in an average annual rate of return of 39.5 per cent over the nine year period. Only one year, 1968, in the last six has been unprofitable which is significant because the market has been more volatile since 1965. There were thirty-six possible holding periods and rates of return were positive in twenty-two periods and negative in the other fourteen. Most of the returns were highly correlated with the absolute percentage price move- ments in the Dowaones Industrial Average, with the larger absolute percentage moves associated with high returns and the smaller absolute percentage moves associated with low or negative returns. It was also shown that more than ninety per cent of all straddles purchased were exercised in twenty-seven periods whereas less than ninety per cent were exercised in only nine periods.. A more important question is not how many Options were exercised, but how many were exercised profitably versus unprofitably. More options were exercised profit- ably in fourteen periods, more unprofitably in nineteen 85 periods and three periods were even. Because the average profit per option exercised was larger than the average loss per option exercised, positive rates Of return were earned in five periods having more unprofitable options and the three even periods. Finally, it was shown that upward and downward moving markets contributed equally to profits and losses. 5. In step five, the results of this study were compared with other studies involving the purchase of straddle Options, with market performance and with mutual fund performance. The first comparison was made with Zieg's results and his average rate of return of 72.7 per cent was much larger than the average of 47.6 per cent in this study. However, differences in purchase and exercise dates were partly responsible for some of his larger returns plus many of the stocks in his study were listed on the American Stock Exchange. Next, the results, recalculated on a mid-year basis, were compared with Zweig's medium volatility class and the returns in this study were superior in four years, comparable in two year and inferior in only one year. The average annual rate of return was much larger and risk, measured by the coefficient of variation, was lower. In comparing the returns with the returns from the DowaJones Industrial Average and Standard and Poor's 500 Stock Index, the average annual rate of return was much 86 larger and unexpectedly, risk was lower. The final comparison was made with the growth oriented mutual funds because of their high-risk, high- return investment philosOphy. The average annual rate of return for this study was approximately four times larger while risk was lower. Qualifications 1. As is true Of most historical studies, the possibility exists that past observations may not render valid generalizations about future results. This has been partially offset by a long time period, nine years, but a more important requirement is that the market remains as volatile in the future as it has been in the past. If this happens, these results could be duplicated in the future. 2. Another drawback is that straddle Options may not be available on all stocks selected. Restricting the selection process to New York Stock Exchange stocks cer- tainly improves the chances of being able to purchase straddle options as does the restriction that straddles are only purchased if the price is within the $30 to $100 range. 3. Another limitation is the constant premium of twenty-three per cent applied to all straddle purchases. Obviously, relative Option premiums will vary depending upon many factors including some related tO the stock specifically and others related to the market in general. 87 4. Another limitation is the assumption of a tax- less environment which certainly does not apply to most individuals and institutions. 5. The assumption that all Options are not exer- cised until six months have lapsed is necessary to calcu- late rates of return. Allowing interim trading may have improved the results, but would have complicated the whole strategy. 6. A final limitation is the use of the coeffi- cient Of variation as a measure of risk. It is a relative measure of dispersion but perhaps a more meaningful measure might be the semi-variance which measures variability in one direction, in this case from the mean downward. Also, the arithmetic mean is used to calculate the standard devi- ation and this produces an upward bias because it gives greater weight to increases than decreases. The geometric mean should have been used as a measure Of central tendency. Implications This study has some implications for the random- walk theory, mutual fund performance, and economic theory. The broad version of the random-walk hypothesis states that present stock prices reflect all past public information and that superior performance is extremely difficult to Obtain by using only past,public information. This study uses all past public information to make invest- ment decisions and the high returns refute to some degree the broad version of this theory if the assumption can be 88 made that options are efficiently priced. While admittedly a unique way of empirically testing this theory, this study proves that special institutional situations do exist in the stock market where past.public information can be used to generate profits. Most mutual funds have not outperformed either the general market indexes or portfolios comprised of ran- domly selected stocks. This statement is well supported by many empirical studies, the earliest of which is commonly referred to as the "Wharton Study.” The authors found that from 1952-58, the Standard and Poor's Composite Common Stock Index was definately superior to the average 1 But when adjustments were made performance of the funds. for asset composition, the average performance by the funds did not differ appreciably from what would have been achieved by an unmanaged fund with the same division among asset types. This study was recently updated to cover 136 mutual funds from January 1960 to June 1968 and comparisons were made with unmanaged portfolios selected at random.2 These random portfolios were either unweighted-equal dollar investments made in all stocks-or weighted by the number of 1Irwin Friend, F. E. Brown, Edward S. Herman and Douglas Vickers, A Study of Mutual Funds, (Washington, D.C.: U.S. Government Printing Office, 1962), pp. 9-21. 2Friend, Blume and Crockett, Op. cit., pp. 50-69. 89 shares outstanding. The average rate of return on the un- weighted portfolios was larger than the average rate of return on the mutual funds (12.4 per cent versus 10.7 per cent) while the average return on the weighted portfolios lagged behind both (9.9 per cent). Sharpe compared the performance of thirty-four mutual funds with the Dow-Jones Industrial Average from 1954 to 1963.3 He concluded that fund managers selected portfolios that were comparable to the Dowaones Industrial Average but fund holders received inferior returns because of management expenses. In light of the above evidence, Tables 4-5 and 4—6 show that an investment in these straddles Option port- folios is certainly a worthly alternative to either pur- chasing mutual funds Or buying the averages. In all com- parisons, the average rate of return was much higher and risk, measured by the coefficient of variation, was lower. The results of this study also contradict economic theory which states that investors, on average, can realize higher rates of return only by assuming greater risk. In other words, a positive relationship exists between risk and return. This long-standing theory is generally ac- cepted by most investors and has much empirical support. The University of Chicago study found that 3William F. Sharpe, "Mutual Fund Performance“, Journal of Business, Vol. XXXIX, No. 1, (January, 1966), pp. 119-138. 90 investors received an annual rate of return of 9.3 per cent by making equal dollar investments in all common stocks listed on the New York Stock Exchange between 1926 and 1955.4 This return is higher than the average yields on bonds over the same time period thus reaffirming the risk-return proposition. This is also supported by the Hickman bond study which found that realized yields on low- grade corporate bonds, on average, were higher than on high-grade bonds from 1900 to 1943.5 Soldofsky and Miller found positive risk-premium curves for fifteen different risk classes of long-term securities from 1950 to 1966.6 Sharpe came to the same conclusion in studying thirty-four mutual funds from 1954-63; those showing greater returns also had greater variability of returns.7 The average return in this study is approximately six times greater than the average market return, yet the risk is lower. It is approximately four times greater than the average growth fund return over the same time 4Lawrence Fisher and James H. Lorie, ”Rates of Re- turn on Investments in Common Stock: The Year-By-Year Record, 1926-65.“, The Journal of Business, Vol. XXXX, No. 3 (July, 1968), pp. 291-316. 5W. Braddock Hickman, Coppprate Bond Quality and Investor E ience, (Princeton, New Jersey: Princeton University Press, 1958), Chapter 1. 6Robert M. Soldofsky and Roger L. Miller, ”Risk- Premium Curves for Different Classes of Long-Term Securi- ties, 1950-1966,“ Journal of Finance, Vol. XXIV, NO. 3 (June, 1969), pp. 429-445. 7Sharpe, op. cit. 91 period and again the risk is lower. On a risk-return proposition, this has definitely been a superior invest- ment strategy and contradicts the prOpositon that higher rates Of return can be realized only by assuming greater risk. This is not the only instance when this theory has been contradicted. Harold Fraine studied corporate bond performance during the same period covered by Hick- man and concluded that realized yields on high quality bonds were substantially higher than those on speculative bonds even though promised yields on the high quality bonds were lower than on the speculative bonds.8 He essentially eliminated the realized and unrealized capital gains due to the sharp drOp in interest rates and corres- ponding rise in bond prices between 1932 and 1943 before calculating realized rates of return. His results were Opposed to Hickman's and also to the risk-return proposition. Many also believe that the results Of the Univer- sity of Chicago study may not be duplicated in the future.9 Because of the availability of historically high bond yields and the past secular rise in price-earnings ratios, common stocks may not provide higher returns, on average, 8Harold G. Fraine, V luation of Securities Holdings Of Life Insurance Companies, (Homewood, Illinois: Richard D. Irwin Inc., 1962 p. 46. 9Fisher and Lorie, 2p. cit. 92 than bonds in the future even though they are riskier.10 In summary, this strategy for purchasing straddle Options has achieved superior returns in a manner that contradicts much of current financial theory. It uses past, public information to consistently generate returns much larger than either market or growth orientated mutual fund returns; something the random-walk theory says is difficult to achieve. Others would say that these high rates of return must be earned at the expense of higher risk. But just the Opposite is true, because the coeffi- cient of variation is lower than that for the market and mutual funds, thus indicating lower risk. 1°Lemont K. Richardson, “DO High Risks Lead to High Returns?“ Financial Anal at Journal, Vol. 26, No. 2 (March-April, 1970), pp. 88-59. 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Spadaro, George M., “Puts and Calls“, Commepcial ppd Fingpcial Chronicle, Vol. 211, NO. 6992, May 7, 19 O , pe 21e Stoll, Hans R., “The Relationship Between Put and Call Prices“, Journal of Fin ce, Vol. XXIV, NO. 5 (December, 1969), 801-824. 96 Taylor, Howard M., “Evaluating a Call Option and Optimal Timing in the Stock Market“, Mana ement Science, Vol. 14, NO. 1 (September, 1967), 111-120. ”Trading on a Shoestring", Financi l WOrld, Vol. 123, NO. 3, (January 20, 1965), p. 7. “Traders Take to an Arcane Art“, Business Week, MCMLXVII (May 13, 1967), 153-158. Zieg, Charles, Jr., A Study of Common Stock Options from phe Stgpdppint of the Returns Accruing to the Buyipg and Sellipg Sides, Published Ph.D. Thesis, Department of Business Organization, The Ohio State University, Columbus, Ohio, 1968. Zweig, Martin Edward, An Analysis of Risk and Return on Put and C311 Option Stratpgies, unpublished P .D. Thesis, Department Of Accounting and Finance, Michigan State University, East Lansing, Michigan, 1969. _fi__, "New Technical Tool“, Barron's, November 30, 1970, p. s. """-- APPENDICES APPENDIX A RANDOM SAMPLES: 1961-70 Table A-1 1961 Random Sample Compm/ Name Volatility 1 Allied Mills Incorporated .364 2 American Can Company .350 3 AMP Industries .553 4 AMP Incorporated .474 5 Armstrong Rubber Company .421 6 Beatrice Foods Compny .462 7 Borg-finer Corporation .335 8 Carborundum Compny . 324 9 Cessna Aircraft Compny .394 10 Cluett Peabody a Company .421 11 Continental Steel Corporation .546 12 Crown Cork a: Seal Compny 1.040 13 Delta. Air Lines Incorporated .744 14 Emerson Electric Manufacturing CO. .554 15 Falstaff Brewing Corporation .2 57 16 FMC Corporation .450 17 General Cable Corporation .256 18 Genesco Incorporated .302 19 Graniteville Compny . 500 20 Momill Paper Company .297 21 Hershey Chocolate Corporation .578 22 Inspiration Consolidated Copper .553 23 Interstate Deprtment Stores 1.031 24 Kelsey-Hayes Company . 377 25 L-O-F Glass Compnv .225 26 Macy 11.11. a: Compny .503 27 MCA Incorporated .785 28 Merck a Company .252 29 Mobil Oil Company .300 30 Natiorml Stanard Compny .255 31 Otis Elevator Compny . 370 32 Perkins-Elmer Corporation . 629 33 Pittston Compny .359 34 Republic Steel Corporation .201 35 Rohn 8c Haas Compny .290 36 Signode Compny .311 37 Standard tollslmn Industries .718 38 Stokely Van Camp Incorporated .971 39 TRW Incorporated .398 no 0 399 United Air Lines 97 98 Table A-2 1962 Random Sample County Name Volatility 1 Acme Markets Incorporated .439 2 Amends Petroleum .448 3 American Enka Corporation . 563 4 Amsted Industries Incorporated .471 5 Associated Dry Goods Corp. .373 6 Bendix Corporation .447 7 Brown Shoe Company .347 8 Celenese Corporation of America .431 9 Cleveland Cliffs Iron .416 10 Continental Oil Company .254 ll Cutler-Hammer Incorponted .488 12 Du Pont E. I. . 371 13 Federal-Mogul Incorporated .313 14 Gamble-Skogmo Incorporated .427 15 General Mills Incorporated .446 16 Goodrick B.F. . 664 17 Could Incorporated .562 19 Inmont Corporation .442 20 IeTe & Te Incorporated .556 21 Keebler Incorporated .396 22 Kraftco Incorporated .437 23 Megmvox Company . 546 24 M C A Incorporated . 818 25 M-G-M Incorporated .75“ 26 Monsanto Chemical . 398 27 National Steel Compny . 562 28 Owens-Illinois Glass Company .400 29 Phelps Dodge Corporation .333 30 Polaroid Corporation .923 31 Revlon Incorporated .743 32 Safeway Stores Incorporated .499 33 Smith. Kline a: French .465 34 Sterling Drug Incorporated .496 35 ‘lalcott James Incorporated . 618 36 Union 011 of California .443 3? Us Se Gypsum Compny “+69 38 Varian Associates . 688 39 Whirlpool Corporation .356 40 Zenith radio Corporation 0557 99 lable A-3 19 63 mndom Sample Coupny Name Volatility l Address-Multigraph .444 2 American Broadcasting-Par. .312 3 American Metal Climax .266 4 Armstrong Cork Company .494 5 Bausch 5: Lamb Incorporated .365 6 Borden Company .167 7 Carpenter Steel Company .247 8 Chrysler Corporation . 645 9 CBS Incorporated . 665 10 Crane Company . 380 11 Delta Air Lines Incorporated .645 12 kstern Gas 5: Fuel .500 13 Fairchild Camera 3: Instruments . 523 14 First National Stores 1116. .200 15 General Cigar Compny .312 16 Gimbel Brothers Incorporated .265 17 Could Incorporated .220 18 Helme Company .168 19 Inland Steel Compny .2 52 20 I '1‘ a: T Incorporated .286 21 Keebler Incorporated .294 22 Leesona Corporation .712 23 Mallory PR 8: Company .282 24 McGraw-Edison Company .163 25 Mississippi Developnent Co. .239 26 National Gypsum Company .212 27 Olin Hathieson Chemical .413 28 Pepsi-Cola Company .241 29 P-P-G Industries .151 30 Ronson Corporation .475 31 Reynolds Metals Incorporated .451 32 St. Joseph Minerals .721 33 Simplicity Pattern Company .557 34 Standard 011 of New Jersey .270 35 Swift 3: Company .158 36 Trans-World Airlines 1.026 37 United Shoe Machinery .183 38 Union Camp Corporation .211 39 ”001mm Fe H. e260 4O Xerox Corporation .995 100 Table A-4 1964 Random Sample Company Name Volatility 1 Air Reduction Comprw .180 2 Anerican Cyanamid .188 3 American Airlines Inc. .383 4 Amher-hniels-Midland .177 5 Bendix Corporation .195 6 Brown Shoe Company .220 7 Central Soya Company .349 8 Clark Equnent Compny .326 9 Continental Can Compny .233 10 Cutler-Hammer Incorporated .406 11 Deere a: Company . 326 12 Dover Corporation .435 13 Evans Products Company .783 14 Firestone Tire .206 15 General American Oil .258 16 Georgia Pacific Corporation .337 17 Gulf Oil Corporation .289 18 Hart Schnaffner l: Marx .522 19 Houdaille Industries . 249 20 International Minerals 5. Chemicals .328 21 Joy Manufacturing Company . 611 22 Kroger Compny . 365 23 Marathon 011 .211 24 McDermott JR a: Company . 606 25 McGraw-Hill Company .300 26 Miles Labs. Incorporated .212 27 National Cash Register .289 28 National Airlines Inc. .542 29 Pennalt Chemical .199 30 Pitney-Bowes Incorporated .261 31 Reliable Stores Corporation .497 32 Reynolds R. J. Totacco .297 33 Schlumberger .281 34 Smith Kline a: French .239 35 Sterling Drug .209 36 Storer Broadcasting . 322 37 Trans Union Corporation .455 38 "0 8. Gypsum .255 39 Vornado Incorporated .714 40 thyne-Gossard Corporation .200 101 Table A-5 1965 Random Sample Company Name Volatility 1 Addressograph-Multigraph .479 2 Amerada Petroleum .231 3 American Smelting .454 4 Armstrong Cork . 322 5 Babcock a: Uilcox .283 6 Bliss a. Iaughlin .202 7 Burndy Corporation 1.028 8 Central Soya .450 9 Cleveland Cliff Iron .470 10 Continental Oil Co. .204 11 Crown Zeller‘nack .246 12 Deere a Company . 335 13 Dome Mines Ltd. .280 14 Evans Products .579 15 Firestone Tire .209 16 General American Trans. .354 17 General Dynamics Corp. .643 18 Getty Oil Company .564 19 Heublein Incorporated .534 20 Inland Steel Compmr .150 21 International Pipe .431 22 Kaiser Aluminum .363 23 Kraftco Incorporated .170 214‘ they Re Ho & Company 0281 25 McCraw-Edison .610 26 Metromedia Incorporated .465 27 Midwest Oil Corporation .312 28 North American Phillips .308 29 Phillips Petroleum .202 30 Pan-American Aimys .751 31 Quaker mts Comrany .232 32 Rickardson-Merrell .422 33 Schering Corporation .503 3+ Simplicity Pattern Co. .277 35 Stauffer Chemical .276 36 Storer Broadcasting .707 37 Timken Company .236 38 U. 8. Freight .340 39 Vendo Company . 652 40 Uestern Union . 552 102 Table A-6 1966 Random Sample Company Name Volatility 1 Acme Markets Inc. .396 2 American Air Filter Co. .588 3 A M P Incorporated . 364 4 Atlantic-Richfield .303 5 Baxter labs. . 611 6 Boeing Company . 696 7 Broadiay-Hale Stores .242 8 Cerro Corporation . 632 9 Coca-Cola Company .252 10 Copper lungs Compny .727 11 C T S Corporation .593 12 Donnelly R a 3: Sons .467 13 Enery Air Freight .514 14 Fairchild Camera .765 15 Freeport Sulphur .476 16 General Tire 8: Rubber .309 17 Grumman Aircraft . 614 18 Hayes-Albion Corporation .353 19 Heinz He Jo Company .528 20 Inteniational Nickel . 317 21 Kaiser Aluminum .538 22 x L M Airlines . 699 23 Macy R. H. a: Company .252 24 MCDonnell Aircraft .489 25 Midwest Oil Corporation .346 26 National Cash Register .431 27 National Airlines . 606 28 Pennsalt Chemical . 383 29 Pittston Company .576 30 myette-Faberge . 624 31 Rohn a: Haas Compny .588 32 Scovill mnufacturing Co. .685 33 Smith Kline 8: French .608 34 Stone & Webster Inc. .412 35 Tectmnix Incorporated .539 36 Texaco Incorporated . 302 37 Ue Se Freight .535 38 Varian Associates .581 39 Vic tor Comptometer . 551 40 White Consolidated . 629 103 Table A-7 1967 Inndom Sample Company We Volatility l Aguirre Company .360 2 American Can .327 3 A M P Incorporated .414 4 American Export .703 5 Becklnan Instrument .626 6 Borg-Varner .473 7 Capital Cities Broadcasting .398 8 Chicago Pneumatic .495 9 Combus. Engineering .655 10 Crowell-Collier .427 11 Cox Broadcasting e 519 12 Donnelly Re Re & Sons .296 13 Emhart Corporation .507 14 Federated Departmnt Stores .333 15 General American Oil .428 16 Goodrich Be Fe 0288 17 Heublein Incorporated . 627 18 Indian Head Incorporated .785 19 I T 6: T Incorporated .525 20 Gulf a: Western Industries .713 21 Kellogg Company .254 22 King's Departmnt Stores 1.028 23 Lear Siegler Incorporated .774 24 McDonnell-Douglas .796 25 Midwest Oil Corporation .208 26 Mattel Incorporated 1.315 27 Norris Industries .806 28 Owens Corning Fiberglas .334 29 Pillsbury Compny .305 30 Robertshaw Controls . 519 31 Ryder Systems Incorporated .694 32 Schenley Industry .775 33 Signode Corporation .364 34 Standard Oil of Indiana .321 35 Sunshine Mining .388 36 Texas Instruments . 370 38 U. S. Shoe Corporation .395 39 V S I Corporation 1.234 40 Host Point Pepperell .530 104 Table A-8 1968 Random Sample Compny Name Volatility 1 Acme Markets .374 2 American Can Compny .244 3 American Brands .318 4 Atlantic Richfield .921 5 Beatrice Foods .405 6 Borg-warmer Corporation .421 7 Campbell Red Lake .280 8 Cheseborough Ponds . 347 9 Collins Radio . 624 10 C P C International .235 11 Colt Industries .525 12 Dow Chemical .219 13 Essex International .466 14 Fibreboard Paper .564 15 c A F Incorporated .569 17 Gulton Industries .655 18 Hecla Mining .467 19 Holiday Inns .692 20 I T 8: T Incorporated .331 21 Keller Industries .899 22 Kinney Service .503 23 Leaseiay Transportation .563 24 McDermott JR 8: Compny .460 25 Miles Labs. 0473 26 M E I Incorporated 1.271 27 National Airlines .609 28 National Distillers .261 29 Pennsalt Chemical .303 30 Purex Corporation .339 31 Republic Corporated .844 32 Reeves Brothers Inc. .514 33 Seagrave Corporation .826 34 Smith A. O. .478 35 Sun 011 Company .346 36 Texas Gulf Sulphur .526 37 Trans Union Corporation .598 38 U. S. Industries .652 39 V S I Corporation .430 40 Whirlpool Corporation . 372 105 Table A-9 1969 Random Sample turner Iambert Company Mans Volatility 1 Allied Pds. Incorporated .686 2 American Smelting .585 3 Archer-Innisls-Midland .464 4 A R A Service .227 5 Bendix Corporation .444 6 Burroughs Corp. .412 7 Caterpillar Tractor .368 8 Cinne Mlmmn .1406 9 c B S Inc. .358 10 Crown Zellerback .334 11 Deere a: Company .484 12 Dome Mines Ltd. 0705 13 Evans Products .480 14 Fischback 8: Moore .392 15 General Mills .266 16 Granby Mining .398 17 Halli‘mrton .366 18 Hobart Manufacturing .263 19 International Flavors a Frag. .398 20 J ohn-Mansville .447 21 Kendall Company . 641 22 Kinney National Service .733 23 Lucky Stores .444 2“ MCDemOtt Jo Re 0 617 25 M M M .230 26 McLean Trucking .423 27 National Standard .423 28 Marco Scientific .441 29 Pepsi Comp-Iv .226 30 Polaroid Corporation .347 31 mybestos-Mnkt. .312 32 Hahn & ms .364 33 Scovill Manufacturing .365 34 Singer Manufacturing . 343 35 Standard Oil of Indiana .486 36 Sun Oil Company .528 37 Texas 011 a Gas .417 38 Uarco Corporation .354 29) United Brands .732 .348 106 Table.A-10 1970 mndom Sample Company Mane Volatility 1 Akzona .371 2 American Hospital .568 3 Arch-Ihni els-Midland . 516 4 Bearings Incorporated .395 5 Boise Cascade Corporation . 632 6 Burroughs Corporation .756 7 Cleveland Cliffs Iron .514 8 Consolidated Foods .529 9 Copeland Refrigeration .713 10 DOW Chemical 0239 11 Eckerd Jack Drugs .826 12 Farah Manufacturing .471 13 Ford Motor Co. .417 14 General Mills .483 15 Gillette Company .524 16 Hall Printing .540 17 Heublein Incorporated . 529 18 Inspiration Consolidated Copper . 667 19 Jewell Compny .369 20 Keebler Incorporated . 630 21 L-O-F Glass .470 22 Macy R. H. 8: Company .513 23 Masco Corporation .477 24 McLean Corporation .450 25 M M M 0473 26 National Biscuit .366 27 Occidental Petroleum . 623 28 Pepsi Compny .374 29 Polaroid Corporation .879 30 Reeves Brothers . 615 31 Rubbermaid .276 32 Scovill Manufacturing .556 33 Singer Company .475 34 Standard Brands .344 35 Sterling Drugs .461 36 Tandy Corporation .756 37 Union Oil California .520 38 V F Corporation .622 39 Vickes Corporation .710 40 Zapta Norness 1.098 APPENDIX B INVESTMENT CHARACTERISTICS PRECEDING UPPER AND LOWER QUARTILE STOCKS: 1961-7O Table B-1 Investment Characteristics Preceding Upper and Lower Qinrtile Stocks: 1961 Sample 1960 1960 1960 1960 Upper Quartile Volatility Turnover Shares Rating Out. (000's) AMF IDde 0600 0357 7769 3 Crown Cork a Seal .459 .546 979 5 Ehnerson Electric 0513 0367 2188 5 Hershey Chocolate .447 .031 2406 3 Inspir. Consol. Cop. .380 .202 1182 5 Interstate D. Str. . 533 .852 391 5 MCA Inc. .579 .101 3996 5 Stokely Van Camp . 300 . 104 1880 5 Average 0 508 06543 2399 ’40 6 W Falstaff Brewing .454 .081 1972 4 General Cable 0336 0072 3062 5 Genesco Inc. .453 .116 3711 3 Hammermill Paper 0228 .060 1’468 ll. L-O-F Glass Co. .411 .099 10469 3 Merck a. C0. .276 .103 10666 3 Mobil Oil Co. .197 .056 48601 2 National Standard .446 .036 1051 3 Republic Steel .476 .090 15708 3 Rohm a: Haas .253 .041 1139 4 Average .353 .075 9785 3.4 107 108 Table B-2 Investment Characteristics Preceding Upper'and Lower Quartile Stocks: 1962 Sample 1961 1961 5:238 1961 Upper Quartile Volatility Turnover Out. (000's) Rating Amer. E1113 08].“' 0358 1308 5 Goodrich B. F. .429 .193 9163 3 Could Inc. . 691 .173 1737 4 “CA Inc. 0785 0083 W]. 5 M'G’M IROe 0 517 0 871 2526 1" Revlon Inc. 0750 0587 5299 5 Polaroid .307 .313 3897 5 Talcott Inc. .599 .179 2677 4 Varian Assoc. .679 .405 3832 5 Zenith Radio . 876 .498 9032 4 Average .645 .366 4351 4.4 Lower ile Assoc. Dry Gd. .495 .102 1905 4 Brown Shoe .356 .039 1877 3 Cont. Oil .266 .054 21395 3 Du Pont E.I. .314 .030 45972 1 Federal Mogul .381 .053 4889 4 Keebler Inc. .339 .355 952 4 Monsanto .279 .074 28023 2 Phelps Dodge .335 .087 10143 4 Clev. Cliffs Iron 02% 0077 2083 5 whirlpool .257 .118 6261 4 Average 0 326 0 099 12350 304 109 Table B-3 Investment Characteristics Preceding Upper and lower Quartile Stocks. 1963 Sample Upper Quartile 1962 1962 1962 ' Shres Volatility Turnover Out. (000's) mting 1962 Chrysler . 648 .825 9038 4 CBS Inc. .391 .156 9151 3 Delta Air Lines . 727 . 504 1700 5 $81.61?! G0 66 F 0 0 5""5 e 382 2913 5 Fairchild Camera .777 1.151 2535 5 Leesona Corp. .989 .703 822 5 Sta J08. Minerals 01481 0 158 2989 4 Simplicity Rttern . 503 .166 1506 4 m .630 .073 6674 5 Xerox Corp. . 624 1. 201 3852 4 Average 0 632 0 532 4118 14‘ .4 Lower ile Borden 000 0 516 0 060 10567 1 First Nat'l. Str. 0505 0158 1810 3 GOUld 11100 0 562 0 121 1737 4 Helms Corp. . 347 . 098 654 4 Nat'l Gypsum .519 .117 6567 3 P P G Ind. .437 . 089 10611 2 Sflift 66 CO. .444 . 1214’ 5999 3 USM .537 .194 2323 4 Union Camp .319 .117 7791 4 Average .4 53 . 119 5433 3. 1 110 Table B-4 Investment Characteristics Preceding Upper and Lower Quartile Stocks 3 1964 Sample 1963 1963 82:28 1963 Upper Quartile Volatility Turnover Out. ( 000 . 3) Rating Cutler-Manner . 261 . 178 1552 4 Dover Corp. .442 . 339 1389 5 Evans P630 0787 0 623 1460 5 Hart S 6: M .242 . 110 1138 5 Joy Mfg 0 01411 0 502 186+ 5 McDemott J. R. . 392 . 600 3888 5 National Airlines . 626 1. 628 2045 5 Reliable Stores .257 . 096 586 5 Trans Union Corp. .285 . 226 3555 3 VOMO 11100 0 510 0 675 1311 5 Average .421 .498 1879 4. 7 W Air Reduction .204 .257 5033 3 Amer. Cyanamid .269 .106 21934 2 Archer-mniels .129 .17 5 1598 3 Bendix Corp. .230 .180 5424 4 Firestone Tire .219 . 057 28698 3 Marathon Oil 0333 .073 14867 3 M1138 13b. 0 325 0 090 4018 L} Pennsalt Chem. 0 325 0 090 “533 2 Sterling Drug .385 .125 24013 2 fine-6088310. 0 151 0 103 360 4 Average .257 .130 11047 3. 0 111 Table B-5 Investment Characteristics Preceding Upper and Lower Quartile Stocks: 1965 Simple 196b, 1964 3:23:38 1964 Upper Qtnrtile Volatility Turnover Out. ( 000 . s ) hting Evans Pds. .783 .906 1541 5 Getty 011 .357 .129 15984 5 General Dynamics . 549 . 542 10015 5 McClain-Edison .430 e 128 6483 3 Pan Am. Airways .472 .739 14065 4 Storer Brdc stg. o 322 o 150 2035 5 Vendo Co. .472 .329 2639 5 western Union .226 .280 7505 4 Average .41? o 361 6626 he 5 Lo rtile Amends Pet. 0 360 o 1214' 12670 3 Bliss & Laughlin .258 .110 1007 4 Cont. Oil .251 .043 21648 3 Crown 261181:ka o 259 o 07 8 15287 3 Firestone Tire .206 .050 28743 3 Inland Steel .184 .069 18170 2 Kraftco Inc. .329 .058 14494 1 Quaker mts .167 .100 4004 2 311111133 Pet. .182 .10? 3346+ 2 Timken Co. .244 .067 5327 3 Average 0 2m 0 080 19481 2 o 6 Table B-6 Investment Characteristics Preceding Upper and Lower Quartile Stocks: 1966 Sample 1965 1965 53:38 1965 Upper Quartile Volatility Turnover Out. (000. s) Rating Baxter Labs. . 606 .286 2750 4 Boeing Co. .798 . 641 8187 4 Cerro Corp. .347 .493 5651 4 Copper mnge . 667 . 520 1982 5 Fairchild Camera 1.435 3. 889 2576 5 Grumman Aircraft .786 .771 4540 4 KIM Airlines 1. 226 3.256 1999 5 Rayette-Faberge 0759 e 595 27 67 1" Scovill Mfg. .525 .261 1549 4 Hhite Consol. 1. 003 . 627 1077 6 Average .815 1.391 3308 4.5 123213251412 AMP Inc . e 522 e 135 6075 5 Athntic-RiChfield . 309 . 135 11292 2 Broadway Hale .227 .040 3691 4 Coca-Cola .269 .036 28501 2 General Tire .469 . 327 16829 3 Hayes-Albion .467 .404 1490 5 Int ' 1. N1Ckel . 191 . 044 29 635 2 Macy Re H. e 281 e 0114' 4362 3 hfldwest Oil . 312 . 051 2392 5 Texaco Inc . . 174 . 031 135117 1 Average 0 322 e 122 23938 30 2 113 Table B-7 Investment Characteristics Preceding Upper and Lower Quartile Stocks: 19 67 Sample 1966 1966 3112sz 1966 Upper Quartile Volatility Turnover Out. (000's) mting American Export . 800 1.202 1354 5 Gulf & Western . 810 l. 771 7114 5 Indian Head .463 .237 2246 5 King' s Dept. Str. . 517 .418 1691 5 Lear Siegler e 697 e 930 “3’41 5 Mc-Donnell-D .489 .277 16241 4 Norris Ind. e 556 e 227 2638 5 VSI Corp. .419 .115 1353 5 Average . 597 . 589 4478 4. 8 W Aguirre Co. . 366 . 281 743 5 American Can .288 .101 16436 2 Donnelly R. R. .467 . 063 12921 4 Goodrich B. F. .252 .190 9182 3 Kellogg CO. . 347 . 028 17971 2 Owens-Corning e 288 0 16+ 14795 4 Pillsbury Co. .423 .11? 4737 2 Std. 011 of Ind. .291 .0 50 70647 2 Average . 335 .110 17071 3.1 114 Table B-8 Investment Characteristics Preceding Upper and Lower Quartile Stocks: 1968 Sample 1967 1967 $1325 1967 Upper Quartile Volatility Turnover Out. (000. s) Rating Atlantic ~Richfield . 275 . 136 11739 2 Collins Radio .736 1.970 2764 5 Georgia--1330 o c 50“ e 116 19021 ’4' Gulton Ind. .935 1.434 3068 5 Holiday Inns .974 .274 11304 5 Keller Ind. . 510 . 222 1639 5 MEI .507 .230 1116 5 Seagrave Corp. 1.179 2. 604 865 6 U. S. Industries 1. 020 1. 216 3672 5 Average 0 8’42 1 e 002 5802 u’ e 8 Jam; manila American Can . 327 .151 17564 2 Amer. Brands .266 .135 28107 2 Campbell Red Lake .531 .239 3999 6 CPC Int'l. .316 .129 22232 2 Dow Chemical .414 .068 30081 2 IT 8: T Inc. . 525 .135 24970 3 Nat'l. Distillers .276 .129 12723 3 Purex Corp. . 674 . 542 7555 4 Sun 011 00. 0,466 c 0114' 25118 2 Average .419 . 165 17705 2. 8 115 Table B-9 Investment Characteristics Preceding Upper and Lower Quartile Stocks 3 1969 Sample 1968 1968 31112325 1968 Upper Quartile Volatility Turnover Out. ( 000 . s) Rating Allied Pds. .625 .935 1728 5 Amer. Smelting . 687 . 344 14555 3 Deere 8: Co. . 263 . 183 14794 3 Dome Mines . 561 . 965 1947 5 Kendall CO. e 370 e 122 3208 3 Kinney Mt . 1 e SVC e e 503 e 377 2597 5 MCDBmOtt J 0 Re .460 o 360 6325 4 Std. 011 of Ind. . 289 . 063 70856 2 United Brands . 645 . 812 8058 5 Average eu75 01418 15085 30 7 W ABA Services . 530 . 179 4241 5 Crown Zellerhck 02033 c 15"} 15316 3 General Mills . 245 . 136 17772 2 HORN Mfg. 0475 cam 5&5 ’4 Pepsi Co. .446 . 118 22196 3 Polaroid Corp. .417 . 29 5 31712 4 Raybestos-Man. .389 .330 1176 3 Singer Mfg e 0 3+5 0 221 13962 2 Narco Corp. 0 383 e 1% 2051 ‘4' Average .405 . 167 16833 3. 2 116 Table B-10 Investment Characteristics Preceding Upper'and Lower Quartile Stocks: 1970 Sample 1969 1969 311.232. 1969 Upper Quartile Vblatility Turnover Out. (000's) Rating Boise Cascade .350 .270 29417 4 Burroughs .412 .337 17232 3 Eckerd Jack .640 .227 6821 5 Inspir. Consol. Cop. .329 .244 2406 5 Keebler Inc. .397 .321 958 4 Polaroid e 347 o 353 32828 4 Tandy Corp. .500 .477 3982 6 Uickes Corp. .387 .201 6974 4 Zapata Norness .723 .973 4214 5 .Average .451 .355 10633 4.0 W Bearings Inc. .371 .224 997 4 Dow Chemical .222 .124 30216 2 Ford.Motor .298 .078 109317 3 Jewell CO. .256 0150' 6626 3 Pepsi CO. e 226 e 1014' 22386 3 Rubbermaid .410 .217 1754 4 Std. Brands .197 .106 13193 2 Sterling Drugs .320 .079 36667 2 [Average .282 .136 24275 2.8 APPENDIX C INVESTMENT CHARACTERISTICS PRBCEDING STOCKS SELECTED: 1962-7O Table C-l Investment Characteristics Preceding Stocks Selected for 1962 1961 1961 $1133.13. 1961 Company Turnover Volatility Out. ( 000 . 8) Rating ACF Ind. e 503 . 566 1422 B Amphenol Borg . 642 . 622 140+ C+ Bliss E. w. .772 .796 1235 0+ Certain-teed Pds. 10 757 1 e 188 2554 0+ Collins Radio . 701 . 541 2213 C+ Comm. Solvents . . 586 2863 01- Crown Cork . 627 1. 0+0 1020 04- D0113 Air Lines e708 e744 1122 0+ Interstate D. Str. 1. 663 1. 031 1119 C+ Korvette E. J o 10 50"" 10272 3989 0+ LOBBOIE Corp. 0 51"“ 0 9‘8 821 0+ Lockheed Corp. . 671 . 648 7 544 0+ LOOK. 8 he 0 658 c 989 2670 0+ Magma Copper .870 .593 1265 C "@611. Line. 0 563 e 648 2395 0+ Mays Jo U. 0 795 e 693 920 0+ McDonnell .598 .693 3425 0+ ”-6-” Inc. 0 871 o 517 2522 B Northrop Corp. . 585 . 50+ 4152 C4- Northwest Airlines . .716 1385 C-I- Perkins-Elmer . 507 . 629 1256 C Revlon Inc. . 587 .750 5256 C+ 81.6.. Kollsman lo 675 e 718 208? 0+ Twentieth Cent. -Fox . 683 . 589 2496 B U M c Corp. .671 .767 5011 B Univ. 011 Pds. .887 .780 2935 C Vendo Co. .599 .595 2623 B 118 Table C-2 Investment Characteristics Preceding Stocks Selected for 1963 1962 1962 3:233 1962 Company Turnover Volatility Out. (000.8) Rating American Eula .487 . 563 1300 0+ Beckman Instrument 1.209 .843 1534 C+ Cenco Instruments .785 .827 1109 0+ Chrysler .825 .648 9035 B Collins &: Aikman .708 .558 1101 0+ Crown Cork .564 .572 4368 C+ Delta Air Lines .504 .727 1700 C+ Fairchild Camera 1.151 .777 2526 C+ Financial Fed. .493 .777 1869 NR General Precision .602 .744 1643 0+ Lilton Ind. 1.758 .666 9668 0+ Magnavox .496 .546 7325 B McDonnell .535 .552 3475 0+ M-G-M Inc. . 608 .754 2569 B Northwest.Airlines .491 . 1385 C+ Perkins-Elmer .569 .795 1287 C Polaroid 2.175 .923 3921 C+ Texas Instruments .734 .876 3947 C Univ. 01]. Pds. e «)9 e705 2957 C vamn ASSOC. o 530 o 688 3917 G!- Xerox Corp. 10201 e624' 3849 B 119 Table 0-3 Investment Characteristics Preceding Stocks Selected for 196+ 1963 1963 8:228 1963 Compny Turnover Volatility Out. (000's) Rating Aguirre Co. . 923 . 603 743 0+ Amer. Crystal SUE e 1. 2m 0 833 372 B Beckman Instruments . 959 . 618 1559 0+ Control 13.12. 1.973 1.027 #115 0 Ester!) C. 8: F. . 531 . 500 1601 0+ Fair'child Camera 1. 244 . 523 2 53 5 0+ Haveg Ind. 1 . 503 . 824 1023 0+ High Voltage Eng. 1. 812 e 7‘53 23?“ C+ Holly Sugar 1.271 . 646 678 0+ Interstate Do Str. .752 e 604 1263 B Leesona Corp. 1.269 .712 822 0+ Metromedia Inc. .999 .874 1746 c Mueller Brass 1.481 .704 566 0+ National Airlines 1. 628 . 626 1689 C+ National Casting . 680 . 519 624 C+ Northwest Airlines . 918 . 699 1821 C+ Rn Am. Airways . 974 . 879 6340 B Polaroid 1.233 .549 3939 C+ Smith-Douglas 1. 371 . 720 1025 C+ U. S. Smelting 120 2&5 e 708 5'45 0+ Uestern Airlines . 819 .925 1431 C Youngstown S.D. . 825 . 657 677 B 120 Table 0-4 Investment Characteristics Preceding St00ks Selected for 1965 196+ 1964 31112:; 1964 Comrany Turnover Volatility Out. (000. 3) Eating American Export 1.033 .770 1421 0+ Arlans Dept. Str. 1.239 .727 1015 0 Boeing Co. . 501 . 662 8024 B Bucyrus Erie 1.001 .774 1874 0+ Cerro Corp. . 530 . 890 5616 B Ester-n Airlines 1.496 .552 3235 0+ Evans Pds. .906 .783 1539 0+ F1110]? Corp. 0 8‘3 0 796 911 0" General Cigars .509 .692 1527 B General Dynamics . 542 . 549 10001 0+ Joy Mfg. . 514 o 611 17% 0+ Lukens Steel 1. 368 e 68? 99+ 0+ MCDOI‘IIIOtt J 0 Re I 807 e 606 3873 c+ National Airlines 1. 321 . 542 1883 0+ Northwest Airlines . 722 . 583 4564 0+ Pitt Forging . 646 . 804 695 0+ Texas Gulf Sulphur 2.406 1.023 10020 0+ United Artists 1. 332 . 838 1962 0+ Venn-do Inc 0 1. 056 e 711‘ 131]. 0+ Hestern Airlines .932 . 581 4292 C 121 Table 0-5 Investment Characteristics Preceding Stocks Selected for 1966 1965 1965 3112323 1965 Compny Turnover Volatility Ou t. ( 000 . s) Rating 308118 00. 0 6+1 0 798 8109 B Bumdy Corp. 1. 143 1. 028 1200 0+ Collins Radio 1.772 .975 22 57 0+ 0011801 0 -Nair 1. 122 e 792 12,46 0+ Cont. Airlines 1. 860 1.019 3196 0 Control mm 1. 27 5 . 720 7400 0+ Crowell Collier . 701 . 603 3939 0+ Delta Air Lines 1. 129 . 887 6375 B Douglas Aircraft 1.106 .973 4585 0+ Eastern Airlines 2.100 .820 4276 0+ Fairchild Camera 3.889 1.435 2563 0+ Fluro Corp. 1.026 .773 975 0+ General Dynamics . 759 . 643 10091 0+ General Instruments 1. 528 . 911 2639 0 General Mcision 1.204 . 571 1633 0+ Grlimnan Aircraft . 771 . 786 4 518 B Gulf 8: Western 0 733 1 . 084 1932 0+ Int ' 1. Resistance 1. 059 . 723 1494 0+ KLM Airlines 3.256 1.226 2000 0+ L‘T‘V Ins. 1 o 394‘ 1 o 085 17578 0+ Lukens Steel 1. 537 1. 001 2862 0+ National Airlines 3. 049 . 836 4006 0+ Northwest Airlines . 645 .792 4574 0+ Pan Am. Airways .944 .751 14469 B Mytheon CO. 10 018 e 831 [+67 6 0+ S 0 M Corp. 4. 123 1. 194 2694 0+ Texas Gulf Sulxhur l. 119 . 632 10016 0+ U. S. Smelting 1.479 1 . 179 2179 0+ Hhite 00118010 0 627 1. 003 13,-‘1 C 122 Table 0-6 Investment Characteristics Preceding Stocks Selected for 1967 1966 1966 1966 1966 Company Turnover Volatility Shares Out. (000's) mun“ .American Export 1.202 .800 1354 0+ American 3 a: n .722 .769 1535 NR Calumet & Hecla 1.491 .838 2128 0 08.!11816 Corp. 10 036 e 685 1209 0+ Collins Radio 3.743 .779 2736 0+ Comm. Solvents 2.040 .948 3009 0+ Delta Air Lines .698 .646 6375 B Eastern Airlines 2.697 .797 4771 0+ E G a 0 Inc. 1.332 .876 1508 0+ Faberge (Rayette) .802 .624 2767 B Fairchild Camera 5.085 .765 2837 0+ Eansteel Metal 1.085 .721 1374 0+ General Instruments 2.791 .692 2745 0+ Gulf & western 1.771 .810 7889 0+ KIM Airlines 3. 369 . 699 2500 0+ L-T-V Inc. 2.497 .713 2133 0+ Lukens Steel .881 .730 2862 0+ Motorola .746 .869 6103 B Nationa1.Airlines .876 .606 4170 0+ Northwest‘Airlines .601 .731 9150 0+ 000 10.811173]. P91}. 0 7‘73 0 7 56 10415 0+ Phil & Reading .883 .729 299? 0+ Sanders A8800. 1. 257 e 600 187 2 0+ 30“ Corp. 4. 171 0717 “009 0+ Teledyne Inc. 10706 .902 2943 0+ Texas Gulf Sulphur 1.098 .634 10034 0+ Trans world Airways 1.022 .649 8958 0+ U. s. Smelting 2.548 .796 2179 0+ western Airlines .996 .600 4301 0+ Unite 00115010 0 630 e 629 3171. 6+ 123 Table 0-7 Investment Characteristics Preceding Stocks Selected for 1968 1967 1967 5,1223 1967 Company Turnover Volatility 0n t. (000's) Rating Adams Millis 3.660 1.433 796 B Ambac Ind. 1.046 1.117 1696 0+ AVCO Corp. 1. 10L} 0 978 14075 B Cadence Ind. 1.029 1.416 1144 0 City Investing .869 .938 2074 0+ Colt Industries 1.142 1.102 3567 0+ Conzac Corp. lo 380 e 9"? 1193 0+ Control Data 1.905 1.329 7730 0+ Diners Club 1.365 .857 1737 0+ E8861 Int ' 10 e 93“ o 814 8036 0+ Faberge (Rayette) .877 .906 2778 B Fedders Corp. 1.587 1.167 2142 0+ Fuqua Ind. 10 350 e 942 1098 0 General Hosts .849 .902 1638 0+ Granby Mining 1.965 .962 474 c Gulton Ind. 100% e 935 2998 0+ Jim Halter .800 1.012 2617 0+ King's Dept. Str. .937 1.028 2114 0+ LPTBV Inc. 2.142 1.101 3934 0+ Loew's Corp. .930 1.386 190? 0+ McDonald ' 8 Corp. 0 851 1 e 1114' 2639 0+ ”01311311 “30111118 0 821+ 10 082 69 6 B Oak Electro-netics 1.587 .889 1058 0+ Occidental Pet. 1.096 1.004 13056 B Pan Am. Sulphur 2.177 1.006 4747 0 Sanders A3800. 1. 351 e 978 W8 0+ Seagrave 2.604 1.179 813 0 Scientific Data Sys. 1.435 1.129 3833 0+ Stokely van Camp 1.187 1.026 2861 0+ Tandy Corp. 0 802 1 o 184 1280 0 Teledyne Inc. .869 1.150 6947 0+ United Nuclear 1.412 .964 4528 0 U.S. Industries 1.216 1.020 3422 C+ Hard.Foods 1.497 1.154 1901 0 124 Table 0-8 Investment Characteristics Preceding Stocks Selected for 1969 1968 1968 83:28 1968 Company Turnover Volatility Out. (000's) Rating AHK Inc. 1.922 .700 4006 0+ Avnet 11100 10 316 0727 8659 0+ Bath Inc. 1.212 1.155 1046 0+ Bermec Corp. 2.579 1.344 4275 0 Berkey Photo .757 .728 3824 C Cadence Ind. 1.443 .767 1358 0 Certain-teed Pds. 1.005 .892 3532 3+ City Investing .811 .733 9002 0+ 0 entral Foundry 1 e 005 0 9‘3 731 0+ Duplan Corp. .802 1.333 2064 0+ Evans Pds. 1.057 .905 3056 0+ Fansteel Inc. 1.176 .801 1704 0+ Financial Fed. .778 .929 3320 NR General Hosts .886 .709 2450 0+ Granby Mining 1.385 .761 1444 0 Leesona Corp. .781 .701 1756 0+ Loew's Corp. 3.148 1.188 4768 0+ MacAndreus & Forbes 1.212 1.222 973 B MEI Inc. .934 1.271 1138 0+ National General 2.113 .968 3512 0+ Natomas Ins. .990 .835 3730 C Penn.Dixie .940 .711 2763 B Rapidemerican 1.196 .986 3056 B Republic Corp. 1.403 e 8’44 3775 0 Sangamo Electric .907 .777 2580 0+ Seagrave Corp. 1.272 .826 995 0 Tandy Corp. .902 .759 1924 0 125 Bable 0-9 Investment Characteristics Preceding Stocks Selected for 1970 1969 1969 311,223 1969 Company Turnover Volatility Out. (000's) Rating Allied. Pds. o 822 o 686 1800 0+ American R & D 10 173 e 677 6100 NR Cenco Instruments .527 .672 3704 B Collins Radio .908 .713 2968 B Computer Sciences 1.097 .643 12160 0 Copper Range . 880 . 652 2224 0+ Dome Mines .714 .705 194? 0+ Fairohild Camera 1.732 .564 4349 0+ General Am. 011 .545 .777 5622 B Great Hestern Unit. .799 .862 2092 B “31101011311 00. o 673 a 520 M12 B International Ind. .878 .595 5037 0+ Itek Corp. lo 900 e 670 229? 0+ Kinney Nat'l. Soc. .788 .733 5940 0+ Loew's Corp. .774 .843 14376 0+ Midwest 011 1.842 .572 2350 B Natomas Inc. 50705 1.171 3750 0 P81111201]. 01111580. 0 503 o 698 141142 B Pittston Co. .552 .515 4863 B Ryder Systems .696 .504 478? 0+ Sante Fe Int . 1. o 502 e 624 327? 0+ Studebaker-worth .658 .608 6324 B Schaeffer'F & M .982 .541 1830 0+ Balley Ind. 1.025 .805 4060 0+ U.S. Smelting .875 .654 2343 0+ Xtra Inc. 1.303 .796 2232 0+ zapata Norness .973 .723 4204 0+ APPENDIX D PROFIT (LOSS) OR STRADDLES PURCHASED EACH PERIOD Pablo D-l Profit (Loss) 0n Straddles Purchased In 1962 First Second Third Fourth Company Period Period Period Period A01" Ind. $(1228) $(1200) $(601) $ 837 AmphendrBorg 539 NP NP NP Bliss F. v. (308) 551 NP NP Certain-teed 1842 1814 NP NP Collins Radio 584 489 NP NP Comm. Solvents 565 714 NP NP Copeland Refrig. 1010 484 NP NP Delta Air Lines (1060) (395) 1656 859 Interstate D.S. 305 863 (346) NP Korvette E. J. (607) 492 47 (3447 Leesona Corp. 1135 NP NP NP Lockheed (1052) (1124) (193) (804) Loew's Th. 770 1112 NP NP Nagna Copper (84) (306) 162 528 Morgen. Line. 21"? NP NP NP Nays J.U. 676 NP NP NP McDonnell (583) (357) 917 (1106) M-G-M Inc. 550 81 (613) NP Northrop (271; NP NP NP Northwest Airlines 295 (653) NP 811 Perkins-Elmer 1108 (44' 549 £440; Revlon Inc. 1020 871 (688) 233 Standard Kollsman 521 373 NP NP Twentieth-Cent. 574 198 NP NP 0 M 0 770 NP NP NP Univ. 0il Pds. 975 667 (564) 328 Vendo 1472 325 NP NP Total $ 9184 $ 4955 $ 326 $(220) NP means a straddle was not purchased in that period. 127 Table D-2 Profit (Loss) 0n Straddles Purchased In 1963 C First Second Third Fourth ompany Period Period Period Period American Erika $ 30 $ (130) $ 419 $ 2438 Beckman Inst. NF 33 (1421; (“'15 Ceneo Inst. (341) (303) (635 (1118 Chrysler 3263 4875 776 1341 Collins & Ailman (82 1572 493 NP Crown Cork {700 (593) (419) (621) Delta Air Lines 301 268 1106 3309 Fairchild Camera 413 634 (863 91 Fin. Federation (1424 971 (1052 368 General Prec. 444 6+1 (227 (450) Litton Ind. 751 (24 (1026 (1182 “ism-vex 293 (772 (900 37 McDonnell (13083 (1046 (1181 502 n-C-N Inc. (730 £742 (730 (657) Northwest Airlines 320 342 1210 3095 Perkins-Elmer 871 549 458 489 Texas Inst. 207 988 806 620 Varian Assoc. 235 NP up NP Total $(4661) $ 989 $(6426) $ 2842 NP means a straddle was not purchased in that period. 128 Cable D-3 Profit (Loss) on Straddles Purchased in 1964 First Second8 Third Fourth Company period Period Period Period (Aguirre (Central) $ (88) $ (237 3 NP $ NP Amer. Crystal Sugar 208 453 (676) NP Beclunan Inst. 325 (68 320 (917; Control Data NP 783 (762) 997 Eastern 0. a F. (14273 973 719 710 Electronic Assoc. (626 424 NP NP Fairchild Camera 474 NP NP NP High Voltage Eng. 191 NP NP NP Holly Suear (97; (86) (624 (356 Interstate Dept. Str. (366 421 (1323 (1088 Leesona Corp. 804 (1075; 1136 (700 Metromedia Inc. (361) (485 (422 663 Mueller Brass 373 34 104 436 Nat'l. Airlines 295 629 (3 798 Nat'l. Casting (405) 680 (747 (157) Northwest Airlines 2368 987 902 1046 Pan Am. Airlines 803 197 (54 NP Smith-Douglas (435) 769 1122 NP U.S. Smelting 998 855 NP NP western Airlines 2117 NP (2993 (782; Youngstown S.D. (668) (835) 821 865 Total $ 3854 $(4721) $(5640) $(3535) NP means a straddles was not purchased in that period. 129 Table D-4 Profit (Loss) 0n Straddles Purchased In 1965 First Second Third Fourth 0”?” Period Period Period Period American Export 3 979 $ NP $ NP $ 675 Ariana Dept. Str. (944) 3386 NP NP Boeing Co. (1489 2456 5108 NP Bucyrus-Erie 2641; 20 1406 546 Cerro Corp. 774 (9+8) 73 756 Eastern.Airlines 77 106 2153 366 Evans Pds. (422) (1024 968 (17) Fin. Federation 541 (132 NP NP Fluor Corp. (463) 602 1925 1145 General Cigars 180 198 (706) NP General Dynamics 593 ( 51) 884 292 Joy Mfg. 319 231 1192 (127) Lukens Steel 584 283 7477 3687 NcDer-nott J. R. 868 (252) 935 282 National.Airlines 707 617 4810 6896 Northwest Airlines 390 (240) 2495 8217 Pan Am. Sulphur 180 198 NP NP Pitt Forcing (749 (748 (390) 133 Texas Gulf Sulphur 974 (1289 2428 3052 United Artists (57 (975 313 363 Vornado Inc. 885 464 1030 222 western Airlines (668) (770) 336 919 Total $(7020) $ 1028 $32442 $27407 NP means a straddle was not purchased in that period. 130 Table D~5 Profit (Loss) 0n Straddles Purchased In 1966 First Second Third Fourth cm?“ Period Period Period Period Admiral Corp. $ 1041 $ NP $ 937 $ 3 Boeing Co. NP NP (1225) 2018 Burndy Corp. (164) (1190) NP NP Collins radio 171 213 (847) 703 Congol.-Nair 581 643 22 NP Cont. Airlines 735 (1249) (1196 1900 Control Data (487) NP 2273 1439 Crouell-Collier 698 (369) 655 (619) Delta Air Lines 2628 NP NP 1147 Douglas Aircraft 2464 3822 93 1097 Eastern Airlines 321 824 NP 1717 Fluor Corp. (1455 (399) (664 NP General Dynamics (998 510 905 813 General Inst. 448 (833 (1070 (1072) General Precision 130 (1334 S318 288 Grumman Aircraft (1077 (50 585 228 Gulf a: western 1999 NP (1992 NP Int'l. Resistance (15 335 (376 (402) KIN Airlines 2890 NP NP NP L-T-v Inc. 1467 736 477 7350 Lukens Steel (4863 864 121 NP National Airlines 235 792 (1894) 247 Northwest.hir1ines NP NP NP 998 Pan Am. Aimys 1008 445 215 856 mytheon Co. (369) (1073) (379) 435 S c M Corp. 1375 1274 237 (625) Texas Gulf Sulphur (1090) NP NP 826 U.S. Smelting 1357 1472 (411) 725 white Consol. 1007 (721) 842 1633 Total $ 2266 $ 2224 $11530 $21705 NP means a straddle was not purchased in that period. 131 Table D-6 Profit (Loss) On Straddles Purchased In 1967 C First Second Third Fourth ”Fwy Period Period Period Period American Export $ NP 3 225 $ 1193 $ (925) American R a D 4960 3220 6272 NP Calumet a Hecla (716) 2250) 996 (626 Carlisle Corp. 746 567 (1328) 427 Collins Radio 3637 93 NP (1029 Comm. Solvents (46) (483) 146 (717 metern Airlines 1351 (1305 955 1238 E G a G Inc. 3022 3383 516 Faberge (Rayette) 1525 852 616 (6173 Fairchild Camera NP NP (1393 931 Fansteel Metal 1608 355 1267 977 General Instruments 1137 2169 (467 493 Gulf a western 1777 (959) (1039 (352) Hecla Mining (80; (1095 (879 352 Ian Airlines (1490 NP NNII: 419 L-T-V 1m. 53 NP Lukens Steel 111 (373) (786) (392) Motorola Inc. 494 NP NP NP National Airlines 822 (1516) (1354) 1505 Occidental Pet. 882 2547 3923 24 Phil 2 Reading 1290 3619 1963 (2168 Sanders Assoc. 1941 293 1735 (800 S C M Corp. (582) 1120 (890) (29 Teledyne Inc. 9091 NP NP NP Trans World Airways (699) 161 (114) 667 U.S. Smelting 788 (583 (1190 (1146) western Airlines (530) (1113 259 1243 white Consol. 114 193 899 319 Total $33673 $ 7746 $ 5532 $(2922) NP means a straddle was not purchased in that period. 132 Table D-7 Profit (Loss) 0n Straddles Purchased in 1968 C First Second Third Fourth “‘1‘“ Period Period Period Period Adams Millis $ (528) $ 323 $ NP 35 NP Ambac Inc. 560 226 375 (830; Avco Corp. 293 291 733 (68 Cadence Ind. (260) 1129 731 1138 City Investing NP 194 550 (1302 Colt Industries 226 $500 (939 1001 Come Corp. 433 669 (1315 (298 Diners Club 479 (18 907 1200 Essex Int'l. 202 2229 183 (594 Faberge (Rayette) (1308) 660 679 (1109 Fedders Corp. 948 2962 989 985 Fugua Ind. (658; (1353) 484 554 General Hosts 221 NP 109 251 Granby Mining 3 398 NP NP Gulton Ind. (28) (972) (568) (155) Jim walter 342 3040 1535 NP King's Dept. Str. 712 4304 NP NP L-T-v Inc. NP NP NP 1535 Loew's Th. NP NP 1585 McDonald's Corp. 145 1611 (442; (1180; Monarch Machine 90 175 (1071 (749 Oak Electro-netics (14) NP NP NP Occidental Pet. NP 211 (1133; (957 Pan Am. Sulphur (673 (794) (831 (47 Republic Corp. (1518 356 277 (1512 Sanders.Assoc. (497 (494) E376 (552 Seagrave Corp. 67 2131 441 (1005 Scientific Data Sys. NP NP (2148 331 Stokely Van Camp 713 (897) 352 (194) Tandy Corp. 399 1800 1370 407 United Nuclear 735 (752) 588 (135 U.S. Industries 875 194 730 (698 Hard Foods (989) (282) 679 347 Total $(6562) $10045 0(10764) $(9912) NP means a straddle was not purchased in that period. 133 Table D-8 Profit (Loss) 0n Straddles Purchased In 1969 First Second Third Fourth Comapny Period Period Period Period AMK Inc. $ 1363 $ (314) $ NP $ NP Avnet Inc. 830 NP NP NP Bath Ind. 1306 (216) (1058) NP Bermec Corp. (1640) NP NP NP Berkey Photo 2069 NP NP NP Cadence Ind. 2890 1780 NP NP Certain-teed Pds. 239 ( 59) NP NP City Investing 215 NP NP NP Central Foundary NP NP NP NP Duplan Corp. 1500 387 NP NP Evans Pds. (805) 343 (641) (635) Fansteel Inc. 795 NP NP NP Financial Fed. (377) NP NP NP General Hosts 480 NP NP NP Granby Mining (98) (317) NP 148 Leesona Corp. 11 1062 6+7 NP Loew's Corp. 622 247 (209) NP MacAndrews & Forbes 868 NP NP NP MEI Inc. 701 856 NP NP National General 346 605 257 NP Natomas Inc. 7119 1158 NP 3535 Penn. Dixie 396 NP NP NP Phillips Ind. (1417) (627) (97) NP Rapid-Anerican 902 380 NP NP Republic Corp. 1974 654 NP NP Sangamo Electric 597 510 NP NP Seagrave Corp. 446 1071 16 NP Tandy Corp. (1994) NP (696) (1311) Total $19338 $ 7520 $(1781) $ 1737 NP means a straddle was not purchased in that period. 134 Table D-9 Profit (Loss) 0n Straddles Purchased In 1970 First Second Third Fourth Company POflOd Period Period Period Allied Products $ 1195 $ NP NP NP American R a D 1568 191 (1008) (339) Cenco Instruments 1487 (587) NP 89 Collins Radio 1513 NP NP NP Computer Sciences 1518 NP NP NP Copper Range 737 2615 299 (223) Dome Mines (285) (1357) (1062) 377 Fairchild Camera 4698 3439 NP NP General Am. Oil 78 (278) NP (357) Great western Unit. 1334 NP NP NP Handleman Co. 857 (31) N) 44 Internatioml Ind. 2094 NP NP NP Itek Corp. 872 1388 (473) (153) Kinney Natl' . Svc. 37 (161; NP NP Loew's Corp. 818 315 NP NP Midwest 011 (1725) 1015 1040 (1193) Natoms Inc. 192 5 1775 NP (927 Pennzoil United 970 NP NP NP Pittston Co. (1254) 489 NP 489 Ryder Systems 361 443 (54) NP Sante Fe Int'l. 591 NP NP NP Studebaker-worth. (464) (378) 985 75 Schaeffer’F & M 281 1169 508 NP Talley Ind. 1995 HP NP NP U. s. Smelting 566 (307) NP (613) X TIE InCe 1288 NP NP NP Zapata Norness 1686 NP NP NP Total $24213 $ 9119 $ 235 0(3495) NP means a straddle was not purchased in that period. ’I BR RIES ((1)1444) HICHIG ((4),) \\\ 2930 0 14420 All)" 31