STEVEN M. SEARS
Options in the Oracle of Omaha's company trade fitfully the first day.
WARREN BUFFETT HAS been quietly active in the options markets for several years, often selling index options that expire in 10 years or more. Now, the Oracle of Omaha is a permanent fixture in the equity-derivatives market.
Options were listed Thursday on class B shares of his Berskhire Hathaway (ticker: BRKB), allowing investors to finally trade puts and calls on a company controlled by the world's most-respected investor.
The news of the options listing was considered so momentous that the Chicago Board Options Exchange, which began trading so-called Baby Berkshire puts and calls today, e-mailed a special press release Wednesday night that immediately generated a few news articles and television coverage. Normally, new listing releases are considered by exchanges (and reporters) as exciting as drying paint.
For years, Berkshire has been glaringly absent in the options market, which does brisk business in all the marquee stocks such as General Electric (GE), Microsoft (MSFT) and Google (GOOG). Suddenly, though, CBOE decided to list Baby Berkshire options. Why? All the exchange would say is that it was requested by a member. The Nasdaq PHLX also listed Baby Berkshire options.
Interest in listing options on Berkshire has always been high on the assumption that investors would rush to the options markets because the cost of a put or call is but a fraction of the price of the actual stock.
The thesis was put to the test Thursday.
Despite the initial excitement, the start of trading was greeted by groans on some trading desks.
For the first hour of trading, no one traded a put or call. Even market makers, who have been known to paint the tape with their own trades to create the illusion of activity in an effort to attract orders to new listings, were quiet.
To be sure, Baby Berkshire is not your typical option. The puts and calls track a stock that costs about $3,000 and barely trades.
This contributes to unusually poor market quality, which makes Baby Berkshire options unattractive to trade.
The spread -- or the difference between the bid and ask -- was recently $20 to $30 wide in at-the-money July and August 2800 calls. In the September and December 2800 calls, the spreads were wider than $30. The spread on the Baby Berkshire stock was recently about $3 wide.
CBOE confirmed Baby Berkshire options are trading in "quote relief," pending a request from the specialist. Quote relief allows market makers to increase the spread -- the difference between the bid and ask -- beyond CBOE's rule that maximum spreads can be $5 wide on all series quoted on their hybrid trading system.
In essence, wide spreads make options more expensive for investors to trade, and more profitable for market makers. The difference between the bid and ask represents the market maker's profit.
"Options traders beware. You're going to have to trade on the quotes, and no one wants to do that. This has to embarrass the person who asked for Berkshire to be listed," a trading strategist says, requesting anonymity for fear of angering the exchanges and specialists trading Berkshire options.
A request for anonymity on a subject as innocuous as the market quality of a new options listing will strike some readers as a paranoid. But in the clubby world of options trading the general tendency among most market participants is to avoid public criticisms for fear of backroom recriminations.
By midday Thursday, 45 Baby Berkshire options had traded.
Indeed, Baby Berkshire options trading will likely suffer if market quality remains poor. This puts added pressure on the market makers who are trading the high-profile, yet potentially difficult to trade options.
Market quality flows from a market maker's ability to easily hedge orders. Ideally, buy orders are naturally offset with sell orders. If not, market makers use sophisticated hedging techniques to eliminate the risk.
For example, no market maker wants to sell a call to an investor and then see the stock price race higher before the market maker was able to hedge the position.
In those situations, market makers lose money because they are short a call, and calls increase in value when stock prices rise. So they use strategies like buying stock or creating "synthetic stock" with various options to reduce, if not eliminate, the directional risk.
The margin of error for market making in Baby Berkshire is very thin. Many stocks trade from $20 to $40 -- which is often the price fluctuation alone of Berkshire's stock. Additionally, Berkshire's trade volume stands at about 36,000 shares each day, making it even more difficult for market makers to hedge.
Until market quality improves, investors who want to gain leverage to Berkshire shares are better served sipping a Cherry Coke, the Oracle of Omaha's preferred beverage, and waiting for the marker makers to figure out how to trade the puts and calls.Related Links
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