I Was Wrong - Sort of

Today was quadruple witching hour. It has come and gone with light trading. This is unusual and may be a very bad thing. Today was the day when options and futures for the next three months expired.

Options and Futures are bets on whether or not a stock will go up or down over the next three months. Lets say your pension fund (the largest investors on Wall Street) needs to make 6 to 8 percent per year. They may sell options that say if the stock increases or decreases beyond a certain amount, the person who bought the option takes the risk. It is a sort of insurance policy for institutional investors. If nobody buys the options than the pension has no insurance policy and cannot limit it's risk.

I had thought that the market was going to crash today, it did not, it did nothing and much fewer than normal trading was done. That means that the institutional investors are basically without insurance. So why weren't the options sold?

My best guess has to do with something the Federal Government announced very recently. They stated that if the market became too volatile that they would halt options trading. This makes options a bad investment. Options make the most money and lose the most when volatility is extreme. It is a question of possible return on investment. No point in buying a lottery ticket if the the odds are 1 in a million if my return is limited to $20.

I personally believe options are a bad thing. I understand the insurance value to the institutional investor; but, it turns the market into a casino rather than an investment. It also leads to people intentionally playing the market and stock values not being representative of the underlying value. I am not against what the government has done, per se. Problem is, the system is built around it and to change it without allowing people to change their format for protecting themselves from risk causes greater risk in the short term.

Now comes the real question, how do the pension funds avoid the risk of volatility at a time when greater numbers of people are retiring, how do they pay them? They end up having to sell off stock. Most likely consequence of this is to drive the price of stock down.

Long term, I think regulating stock trading as promoted by Warren Buffet is a great idea. Eliminate options and limit CEO pay. Base CEO pay on profits and not on stock valuations. These changes force CEOs to make companies work rather than making changes just to increase the short term value of the stock. To threaten to halt stock option trading days before quadruple witching hour; however, is wrong as people have not had an opportunity to find other insurance policies.

To understand the long term impact of these changes will take a little time. I believe that down the road, can't say when, you will see more and more stock in companies being owned by the employees themselves through their pensions. Remember 35% of the stock in GM is owned by the employees own pension funds (50% is owned by the Federal Government).

Basically, what is being created is a new form of large corporation. The employees end up controlling the companies and their retirements are only secure if the company runs well. They end up relying on the future employees to make sure that they have a pension. By ending options trading and tying Management pay to profitability it is believed that the employees and managers will care more about the long term health of the company. That is the logic behind these changes.

I do not believe you can call such a thing socialism unless the government owns 50% of the company. It is more along the lines of true communism where the workers own the means of production. Not a Soviet Union style communism (which was not the workers but the government owning everything). You can call it collectivism of a sort.

Lets say you work for GM. Cars are not selling, will you have the union try and get you a raise if it mean it will tank out your pension fund? Probably not. Will you tolerate lazy fellow employees, probably not. Will it increase animosity between employees, possibly. This is untried territory. How will it effect the relationship between management and employees. Remember the Union will be picking the management. Who will they pick and on what criteria? It will be interesting to see.

What will the managers of tomorrow look like and act like? It will take a little time; but, if this trend continues (and I believe it will) people will be more likely to stay at a job and learn to do it well. I am not promoting this change nor arguing against it, just trying to figure out what the impact will be. My fear is that the employees may be harder on each other than the managers ever were.

We are truly entering a brave new world.