the direction of the market but also their timing must be nearly perfect,
and their selection of the strike price must be appropriate.Selling Index Options
Of course, for anyone who buys an option, someone must sell—or
write—an options contract. The sellers, or writers, of call options believe
that the market will not rise sufficiently to make a profit for options buy-
ers. Sellers of call options usually make money when they sell options
since the vast majority of options expire worthless. But should the market
move sharply against the options sellers, their losses could be enormous.
For that reason, most sellers of call options are investors who al-
ready own stock. This strategy, called buy and write, is popular with
many investors since it is seen as a win-win proposition. If stocks go
down, they collect a premium from buyers of the call, and so they are
better off than if they had not written the option. If stocks do nothing,
they also collect the premium on the call, and they are still better off. If
stocks go up, call writers still gain more on the stocks they own than
they lose on the call they wrote, so they are still ahead. Of course, if
stocks go up strongly, they miss some of the rally since they have prom-
ised to deliver stock at a fixed price. In that case, call writers certainly
would have been better off if they had not sold the call. But they still
make more money than if they had not owned the stocks at all.
The buyers of put options are insuring their stock against price de-
clines. But who are the sellers of these options? They are primarily those
who are willing to buy the stock, but only if the price declines. A seller of
a put collects a premium, but he or she receives the stock only if it falls
sufficiently to go below the strike price. Since put sellers are not as com-
mon as call sellers, premiums on puts that are out-of-the-money are fre-
quently quite high.THE IMPORTANCE OF INDEXED PRODUCTS
The development of stock index futures and options in the 1980s was a
major development for investors and money managers. Heavily capital-
ized firms, such as those represented in the Dow Jones Industrial Aver-
age, have always attracted money because of their outstanding liquidity.
But with stock index futures, investors were able to buy the whole mar-
ket, such as represented by the popular indexes.
Ten years later, exchange-traded funds gave investors still another
way to diversify across all markets at low cost. These ETFs had the fa-CHAPTER 15 The Rise of Exchange-Traded Funds, Stock Index Futures, and Options 267