Options Traders Kick Back, Enjoying the 'Greenspan Put'

"No one buys puts anymore," remarked the head of one options desk with a large Wall Street brokerage firm Friday. "Why would you do that when they go out worthless every time?"

At least one Wall Street brokerage house has a theory about why puts are on the outs with investors: because the Federal Reserve has sold them a free safety net, the only "put" on the stock market they need, a position being dubbed the "Greenspan put." It is becoming a more widely held belief these days.

Volatility Index Today % Change 27.83 +1.87 Source: ILX

And as if on cue, call-buyers hit the usual suspects Friday, and institutional orders rolled in early in the trading day for Compaq(CPQ Quote), Disney(DIS Quote), America Online(AOL Quote) and Nortel Networks(NT Quote).

Put/Call Ratio Today (Noon) Previous Close 0.32 0.35 Source: ILX

Among the most active strike prices were the Compaq, particularly the April 30 calls, up 1/2 ($50) to 1 5/16 ($131.25) on about 7,200 contracts. A showcase trade in AOL crossed on the Philadelphia Stock Exchange, where Susquehanna is the new specialist in the Internet blue-chip's options, in the July 92 1/2 calls, up 1 1/4 ($125) to 2 ($200).

"What we're seeing is that value stocks continue to be a source of funds for the highfliers," the trader said. "And that will continue until everyone and their brother sets up a home E*Trade(EGRP Quote) account. Then we'll see the beginning of the end."

So why bother buying puts in a bull market? Puts give investors the right to sell a stock or index at a certain time and price in the future. That's a good way to profit from them if they fall.

Investors have snubbed buying such bets as they become more accustomed to the idea that Alan & Co. will step in and "save" the market with liquidity infusions, as the Fed did in cobbling together financial giants to rescue Long Term Capital Management during its 1998 collapse.

This theory has been floating around for a while, and it is difficult to price in the value of such an implicit, essentially free "Greenspan put" into the options market, said Steve Kim, derivatives strategist who helped author the Merrill Lynch report.

"The Fed has been acting very differently from the Paul Volcker days," Kim said. "In the '70s, the Fed was essentially powerless over the market, and Volcker was not the type to intervene with liquidity anyway."

In the Age of Alan, however, "there have been a few tests of his resolve, and now people have come to expect an implicit 'Greenspan Protective Put.'"

The Fed has never said this explicitly. "It's more implicit. Whenever the market is jarred, investors embed some new level of premium because of the behavior of the Fed."

Interesting theory. How do you price that Greenspan put option? "It's almost impossible," Kim conceded. "It's not as if you can say, 'that free put from Greenspan creates X floor in the market,' or that it's worth 5 P/E points on the Dow. What is the maturity? What are the terms? We just don't know."

What he and other option strategists do know, though, is that "there is now a perception of a safety net that creates a lower-risk aversion about how investors behave."

Ultimately, he added, the market's larger stocks are the beneficiaries. And it may help explain why volatility -- measured by the Chicago Board Options Exchange's volatility index -- continues to creep higher as the Nasdaq moves higher. Traditionally, when the VIX, the market's fear gauge, moves higher, that foretells a drop in the stock market.

Recently, the VIX has been moving up and outside its historical 17-to-25 range. Friday, the VIX was up 1.28% to 27.67. Meanwhile, the Nasdaq and the Dow continued to diverge, and the Dow teetered on the brink of the 10,000 level.

Kim pointed to this as further evidence that investors are more comfortable with higher risk in the market: They are pricing in the Greenspan put on the stock market. "If some guy in an emerging market country wrote me a put, it's worth nothing. But if the put is written and sold to me by the U.S. government [the Fed], I know they're good for it.

"How tangible is this Greenspan put? That's what people need to consider. The Fed has been good. They have had the power to do it. The question is, will they do it again?"