CHAPTER XIV.

IN THAT RESPECT IS SPECULATION USEFUL IN MARKETS GENERALLY?

[Sidenote: SPECULATION FOR THE RISE, WHICH IS BOTH LEGITIMATE AND OF BENEFIT TO THE COMMUNITY.]

[Sidenote: SPECULATION FOR THE FALL, WHICH IS BOTH LEGITIMATE AND OF BENEFIT TO THE COMMUNITY.]

[Sidenote: A REASONABLE RELATIVE VALUE FOR ALL COMMODITIES.]

The remarks upon speculation in the foregoing chapters may, perhaps, lead the reader to infer that our object has been to enter upon a crusade against all speculators, _guerre à mort_. Such an impression would not be a correct one, and this chapter is intended, just in conclusion, to show why. Speculation in the sense of buying for cash or on ordinary credit what the purchaser has very good reason for knowing is uncommonly cheap, and what he believes will, ere long, improve in price, does not come under the category of speculation such as that to which the foregoing remarks refer. There is hardly an individual who buys anything who is not at times more or less of a speculator, and he has a perfect right so to be under given conditions, and his being so under such conditions is a direct benefit also to the community. For instance, take a very homely article which will serve for an illustration, bacon. Supposing bacon, through some passing influence, were to fall considerably in price, very large purchases would at once be made on speculation, because it is an article almost certain to be directly consumed in a proportion greater than the production could be increased. Large quantities would be taken off the market by both retail and wholesale dealers, who would store it in anticipation of a recovery in value. They probably would not want it for immediate use, and would be induced to run the risk of the operation turning out profitable by reason of its being suddenly so much cheaper than they had been accustomed to buy it. They would, in one word, speculate in bacon, just as some people speculate in stocks after a heavy fall. Unless something had happened to permanently depreciate the value of bacon this rush of buyers, the great majority of whom would soon settle their operations by cash payments, would speedily cause at least a partial recovery in value, which might be followed by a further rise or relapse according to circumstances. Whether anything serious had been at work to depreciate value or not, the innumerable interests that would have suffered by the decline in value would thus be protected at least for a time by the speculative operations referred to. The price would be kept up above what it would have been in the absence of such speculative operations, while either the real or fictitious agency at work in causing a fall were discovered and analysed. So in a converse sense, if for some reason or other the price of corn were driven up very rapidly several shillings per quarter above the value ruling at a particular period, without holders of large stocks being able to discover sufficient cause, many of them would hurry to market and sell what was still even unthrashed. They would be so tempted by the very high price that they would speculate upon such a high quotation being followed by a low one, and they would sell all they could manage to deliver in a given time. The speculator in the bacon would be playing in a legitimate sense the part of the bull, and the speculator in corn that of the bear. It will be admitted that there is what we know as a reasonable price for all things, and that it is better for all concerned that a reasonable relative value is maintained for all articles than that anything becomes either extravagantly dear or so cheap that it is worth no one’s while to produce it. Every article of those consumed by mankind in their several stations has its fitting place either as a necessity or as a luxury. A necessity for some reason may in course of time become a luxury, while, what is much oftener the case, luxuries may by degrees come under the category of necessities. The value of the one or the other may in relation to other necessities or luxuries change, but it will probably change only gradually, and during the process of change there will be a reasonable relative value for such articles. It is important then in order to satisfy the rational desires of all members of the community that the reasonable relative values of all commodities should, if disturbed by any cause, remain so as short a time as possible. The undue inflation or depression of prices will be counteracted by speculative operations such as we have referred to, and in that sense, speculation is directly of immense benefit, as it is one limb of a body of law which administers justice silently but surely to any one who has left one weak point in his armour when attempting by violent or fraudulent means to snatch a profit by unjustifiably raising or depressing prices. The one condition, however, of such speculation being of direct benefit in keeping prices at a level which is in accord with the existing state of supply in relation to the demand at any period is, that the speculative operations shall partake as nearly as possible of the nature of _bona fide_ operations. The great benefit which is caused by the one kind of speculation is the antithesis of the evil which results from the system of “time-bargain” speculation as practised in all markets. The one kind of speculation is the legitimate advantage taken of being able to buy any article cheap, or to sell any commodity that is dear, whereas the other is nothing better than pitch and toss in disguise.

The kind of speculation which is of benefit to the community may be termed corrective speculation, as implying a restoration of prices, through its agency, to a reasonable relative level. Such speculation would come from buyers who had good reason to know that what they bought they would be able again to sell, and that its purchase speculatively was simply the supply of their ordinary requirements in anticipation, owing to a favourable opportunity having presented itself. In proportion as speculation proceeds from simply time-bargain operators will the price be driven up or down, according to circumstances to an injurious degree, as compared with a corrective degree, the influence of the one set of speculators doing good and that of the other set harm.

[Sidenote: THE THREE CLASSES INTO WHICH SPECULATORS MAY BE DIVIDED.]

Speculators may be divided into three classes which about embraces all the phases of speculation. First, we have the legitimate speculator who spends all or some of his surplus capital in taking off the market what he believes will give him a gain by holding it for some time. That is the legitimate speculator who is a benefit to the community as a leveller up of prices. Then we have the legitimate speculator of the same stamp, with a difference that he is a leveller down of prices, and is equally of service to society by immediately throwing on the market all the stock of a certain article he may hold of be able to get for the purpose, when it rises to a price above what he calculated on being able to obtain, and which his experience told him was an unusually high figure. Such speculators as these not only do not hurt themselves, but directly benefit themselves by speculating, and in so doing protect the interests of their neighbours and the community at large. Such as these this book is not written for. We are concerned with those who, classified as illegitimate speculators, and reckless speculators, which, second term may have to be moved a point or two according to circumstances, are over the border-line, whose _dictum_ is “Heads I win, tails you lose.” The illegitimate speculator is the one who starts with a small capital and with some method, with the idea of increasing it upon a system of incurring risks which, in the ordinary course of the market he may operate in, will enable him in case he has wrongly calculated the course of prices, to pay his losses and go on again. His intention is never _bona fide_ sale or _bona fide_ purchase. The reckless speculator is the man who with little more than he stands up in makes a great pretence, imposes upon the weak and credulous, enters the Stock markets and operates to right and left up to the hilt so far as he may be trusted. So long as he may enjoy a run of luck he rakes in the coin; when it turns he leaves his dupes to pay and goes up the country, as they say of the native Indian merchants when the telegraph announces to them that the goods shipped to Europe for which they have drawn, will leave a loss.

We have then one class of speculators which is of direct use and value in all markets, while the other two, the nature of whose operations we have endeavoured to lay bare, cause an infinite deal of mischief, and get in ninety-nine cases out of a hundred no good for themselves in the long run, whether their transactions are entered upon carelessly, and are allowed simply to take their chance, or an attempt be made to achieve success by some exercise or skill.

FOOTNOTES

[1] In speaking of taking profits, the question arises, what is a profit? Some people might say a profit is ½ per cent., and others 10 per cent. Now, of course, it is impossible to give an exact answer to this question. As a general rule, a transaction should not be made unless the chances of a gain are greater than the chances of a loss, but there may occasions occur when it would be advisable to take a small profit. All depends on the condition and temper of the market; but one rule I found to work well, and would recommend to every speculator, namely, that at the moment when a doubt arises in your mind, and you begin to ask yourself whether you ought to take your profit or not, then do not lose one moment’s time, but take your profit, because you can never make a very serious mistake by doing so, while you might possibly make a very serious one by refusing it.

[2] Where it says “for the account,” it applies to the custom of the London Stock Exchange, where all the buying and selling is for the account, say generally the middle or end of the month.

H. W. R.

[3] According to this principle, operations conducted on options are more certain to result in profits in the long run than margin operations. If I assume to make a profit in only one out of every three operations, and each option costs me 1¼ per cent., I will make a profit, if the third option only yields me a profit of more than 3¾ per cent., which is nothing unusual.

H. W. R.

[4] This depends whether it is a bull or a bear market.

H. W. R.

[5] See definitions of these terms, page 20.

[6] Operators means here, what is called in New York, “Insiders” and members of the Stock Exchange.

H. W. R.

[7] I consider this most important, and maintain that “options enable the operator to hold out for the event, or at least for a long time, especially if the process is once or oftener repeated.”

H. W. R.

[8] Very important.

H. W. R.

[9] This hardly applies to the New York market. The so-called larger operators and traders take here the place of the London jobber.

[10] The settlement does not exist in the New York market.

[11] Contango is equal to New York carrying charges—in New York so much per cent. per annum, fixed daily; in London a certain sum from one settling day until the next.

H. W. R.

[12] Equal here to borrowing stock flat, or even paying for the use of it.

H. W. R.

[13] Backwardation is equal to the paying for the use of borrowed stock at the New York Stock Exchange.

H. W. R.

[14] In New York, “flat.”

H. W. R.

[15] Called “straddle” in New York.

H. W. R.

[16] In London all options are for a fixed date; at New York they are generally made so that the option can be exercised at any time during the pending of the contract.

[17] This may be true in a certain sense, but if options are considered as an insurance feature, it is generally expected and hoped that they may not have to be exercised, and will simply answer the purpose of insurance and margin.

[18] This does not apply to the New York market.

H. W. R.

[19] In London all options are made at about the current market price, and the premium paid varies with the character of the stock and length of time, while in New York puts, calls, or spreads are generally so much above or below the market price, and the premium consequently much smaller than at London. The only exception here is the “straddle.”

H. W. R.

[20] This is not considered so in New York, where we generally expect a so-called “January rise,” which, however, sometimes does not come; and also sometimes expect a bear market in the fall of the year, when money is employed to move crops, which, however, also very often disappoints the operator.

[21] Somewhat superstitious. I have often observed it just the other way, although generally a very dull market is expected during the hot summer months.

H. W. R.

[22] This about corresponds with our spring and fall trade, when the newspapers teem with interviews with prominent merchants and bankers.

H. W. R.

[23] Of course, this applies, in a general way, more to the London than to the New York Stock Exchange.

H. W. R.

[24] This applies also to the New York market in so far as that after a large bull speculation there will be heavy realizations, and after a bear campaign or attack the covering process will take place.

[25] This applies to the so-called “lottery loans.”

H. W. R.

[26] Letter to “_Spectator_,” of October 4th, 1873, Saxon-les-Bains: a Study in the Psychology of Gambling.

[27] In New York we have now any number of “bucket shops,” which certainly deserve the name of “gambling hells.”

H. W. R.

[28] To a certain degree the agricultural industry of the United States takes the place of the manufacturing industries in England. Our manufacturing industries, however, are not unworthy of serious consideration.

H. W. R.

[29] I do not think that this has been done yet in this country, principally because the necessary charter cannot be obtained, unless companies similar to the Oregon Transcontinental may be classed as such.

H. W. R.

[30] The generally large increase in speculation in the United States and all the incidents connected therewith are too well known, and too fresh in the minds of the reader, to need enumeration here.

H. W. R.

[31] This is now generally done for the customer by his broker, who endeavors to collect, as far as possible, reliable information and statistics for the benefit of his clients.

H. W. R.

[32] This also applies to important changes or other matters affecting all kinds of corporate property, &c.

H. W. R.

[33] These remarks apply with the same force, if not more so, to grain, provisions, cotton, petroleum, &c.

H. W. R.

[34] I think his remark is worthy of serious consideration.

H. W. R.

[35] At the New York Exchange nothing less than ⅛.

H. W. R.

[36] Even such fluctuations are considered as unworthy of consideration in American railroad stocks, where fluctuations of 10 per cent, and even more, within a comparatively short time, are of frequent occurrence.

H. W. R.

[37] Or through Options at least insure himself against loss.

H. W. R.

[38] In Options, however, the poorer speculator virtually borrows, for a fair consideration, the capital and credit of the rich operator.

H. W. R.

[39] As said before, the settlement in New York is daily.

H. W. R.

[40] All these experiences happen also in the New York Stock market, only in different form, such as railroad wars, law-suits, injunctions, &c.

H. W. R.

[41] Point.

H. W. R.

[42] Sometimes also for the purpose of encouraging first a following, and to unload later on.

H. W. R.

[43] Government Securities.

H. W. R.

[44] The usage at the New York Stock Exchange is different.

H. W. R.

[45] The real type of the London Jobber does not, however, exist in the New York Stock market.

H. W. R.

* * * * *

OPINION AS TO VALIDITY OF “PUTS,” “CALLS,” &c.

Law Offices of SIMON STERNE, 29 William Street, NEW YORK, July 24th, 1886.

H. W. ROSENBAUM, ESQ., 60 Exchange Place, New York,

DEAR SIR:

You ask my opinion as to time contracts known as “puts,” “calls,” and “straddles” or “spreads,” in relation to stocks, bonds, etc. The inquiry is prompted by the apprehension that such contracts may be regarded by the law as of a gambling character, and therefore not enforceable.

Contracts partake of the nature of wagers only when there is no intention either to deliver or to receive the goods, stocks, or bonds, which form the subject matter of the contract. That in point of fact and as a matter of local custom, differences are sometimes paid on the settlement of time contracts instead of delivery being actually made, does not affect the original transaction, and does not invalidate it. So long as there was not a clear intention, either express or implied, that the things themselves were not, under any circumstances, either to be called for or to be delivered, and so long as the holder of the “call” has the right to demand the actual delivery of the stocks or bonds mentioned in the contract, or the holder of the “put” has the right to insist upon the actual delivery of the stocks, bonds or merchandise represented by the “put,” the transaction can, in no sense, be considered a gambling one or partake of the nature of a wager, although, instead of the actual delivery, differences may and sometimes are, as a matter of compromise, accepted for convenience, at the time when the contract is to be enforced.

This practice of paying differences is, as I understand it, much rarer, however, than the actual delivery of the stocks or bonds mentioned in the contract. The courts have of late years, with great uniformity, dealt with these contracts with the disposition to uphold and maintain them, and have discredited the defence of their being of the nature of a wager, and have held the contracting parties to their agreements in the same manner as in every other contract for which a reasonable consideration had passed.

The decision of the Courts of this State, of Massachusetts, Pennsylvania and Illinois, and in the Federal tribunals, where, in one form or another, these contracts have been the subject matter of examination, have been so uniform in that direction that we can now regard this as settled law.

It was only in the infancy of those larger and more complicated mercantile transactions incident upon the development of the modern industrial world, that doubts as to the moral aspect of these contracts could arise. Political science proves, and the law has followed the conclusion, that these time contracts now form a necessary part and perform a conservative function in the economy of a fully developed commercial life. They are an as yet undeveloped form of insurance of values to a purchaser, for which the purchaser pays a fair equivalent, and in process of time such insurances must perform a larger and more important function in the purchase of commodities or of representatives of value which have a tendency to fluctuate largely in price.

For a time it was supposed that the ordinary policy of fire insurance partook of the nature of a bet, and there was doubt as to whether the Courts would enforce contracts of insurance, because it looked as though the insurer was saying to a man who wanted to have his house insured against fire, “I will bet you the value of you house that it does not burn down.” But we have long since departed from this infantile mode of looking at the situation and have learned to regard insurance as one of the conservative elements of modern civilized life, by which heavy losses are evenly distributed instead of coming with crushing effect upon the persons suffering the misfortune.

The capitalist who sells a “put” or a “call” performs precisely the same function as an insurer. He receives an equivalent therefor, and it is a means by which he can turn the securities in his hands with an intermediate profit, without serious risk, except that in the case of a “call” he may be compelled to change the character of his securities, or replace the securities which he has called from him, and in the case of a “put” he may be compelled to re-acquire the securities that he has parted with; but, distributed over a very large mass, and through different classes, of securities, these “calls” and “puts” will balance themselves and leave, if intelligently pursued, a resultant profit to the operator in the “puts” and “calls,” with a prevention of disaster to the purchaser of the privileges, as against excessive fluctuations in the market.

Respectfully yours,

SIMON STERNE.

* * * * *

H. W. ROSENBAUM,

60 EXCHANGE PLACE, NEW YORK,

Broker and Dealer in Options on Bonds and Stocks

Besides the usual Options (Puts, Calls and Spreads) with prices fixed at a certain distance from the market price of the Stocks or Bonds, I devote especial attention to the negotiation of Options (Puts, Calls and Straddles), with price fixed at the current market price of the Stocks, etc., which latter class of Options my experience has proven to be the most advantageous and ultimately cheapest.

I will also contract _Insurances against loss_ on purchases or short sales of Stocks or Bonds, made through me, during periods ranging from one week to sixty days, and in quantities of from 100 shares ($10,000 Bonds), upwards.

The Premiums to be paid for such Insurance range from $112.50 per 100 shares upwards, according to length of time and character of security, and cover the whole loss which the speculator may incur on this transaction.

Circulars, Rates and Information furnished on application.

H. W. ROSENBAUM, 60 Exchange Place, New York.