Ah, a little change of pace here. People keep asking me more about how the derivative markets and equity markets interrelate. I wrote this piece on the fly because I wanted to get the word to you while you could still make up your mind. I am glad I did. However, now I want to return to it as a vehicle for trying to show the interrelation. I will use the piece more as a jumping-off point than as a true textual analysis.

This time it is the


July 730 calls that have people glued to their screen. There were 12,500 contracts still open as of this morning. I doubt that the market can rally through that level, but some of the shorts are worried that the OEX could coattail off the 9% exposure it has to


(MSFT) - Get Report


(Okay, there are two main indices that trade: the SPX, which tracks the S&P 500, and the OEX, which tracks the S&P 100. As Microsoft is the largest company in any index, it can affect both. Options on the S&P 500 expire in the morning, while options on the S&P 100 expire at the end of the day. There was a time when they used to expire together, and it caused such miserable imbalances and confusion that they split them up. If you go back to 1981, there were no such thing as market indices. People would have to speculate, if they wanted to, on individual stocks. But when indices were introduced, they turned the whole market into one big commodity, as if stocks were corn or pork bellies or wheat. You could own a future on the market pegged to a price. Naturally, some opportunistic people thought it would be good to have options on futures and trade quite regularly. So, to get the lineage right, we are talking in this piece of a derivative of a derivative. What is the difference between owning an S&P future and a call on the S&P? The answer is that you are stopped out at a certain level, the strike level on the call, but that you can have massive losses (more than your investment) in a future. That makes futures riskier than calls. I used to trade futures and I found them so mesmerizing that I stopped. I used to trade calls on the indices, too, but I gave that up about a year ago and now do so only occasionally. I will tell you that I found trading calls on the market to be one of the most compelling, exciting things in the world, but that I never made enough money to justify the excitement because, in the end, I am a stock-picker. That said, many millions of people trade these pieces of paper, and because of the numbers that are traded, they can have a direct impact on the stock market. On Friday morning the OEX, the index that expires after the close, was about two points from the strike. If you were feeling bullish -- which is kind of like when Clint Eastwood asks that criminal whether he feels lucky in Dirty Harry -- you might have thought that you could buy these calls for less than $1 to catch a potential upside explosion, which you almost got. I am not as concerned in this piece with the call buyer as the call seller. Let's say you are a market maker. I come to you and I want to buy those calls. You might think, as I did when I wrote this piece, that those will go out worthless. After all, you have one day for the market to make a very big ramp and it seems unlikely at 10:00. But on this particular day, because Mister Softee won its case and Gates went dot-com on everybody, MSFT broke out, which caused the OEX to go higher than most people expected. So you, market-maker, may have sold me that call for a buck. The index closed at 733.79! That's a huge win for me ($2.79 on a $1 investment, or almost a triple in a day) and a mega-loss for you. (If you did not cover, or buy back the call, you got a mark at 733.79 and lost exactly what I won. As you can imagine, if you and everyone else suddenly feels that this market is about to explode to the upside, you will collectively attempt to cover the calls, causing even more upward pressure.)

It is Microsoft that is taking center stage in the options world, however. Everybody who was short the 'Soft July 95s -- 25,000 open contracts as of this morning -- got the head slam usually reserved for the dot-com world as the buyers of Mister Softee laid the July 95 call-sellers to waste.

(This is another short squeeze of sorts. Most people expect stocks to go out around their strikes. The reason for that "pinning" is because people who are long calls sell them to make a little money and people who are long puts sell them to try to recover a little money. Collectively that action forces a stock to gravitate toward its strike. Why does that happen? It helps tremendously if you think of what the other guy, the buyer of your merchandise, can do with it. If you sell a call to someone on the day of expiration, the most likely thing that person will do with it is to short common stock. This is not a bad trade. Let's walk through it. You own a call on Microsoft and nothing is happening to the stock. It is at 95.5. I might be willing to buy that call from you on the Friday of expiration and short the common stock underneath it. That way, if MSFT suddenly crumbles, I have a risk-free short. If it goes up, big deal, I am out almost nothing. Hold it, before you think, what is Cramer smoking, I can tell you that I have done that trade probably several thousand times and it has made me money about 60% of the time. How about the puts? The stock is at 95.5 and you own the July 95 put. You sell it to me; I then go and buy the common stock because I now have a risk-free shot to the upside. Again, this is not a silly trade. If I can trade cheaply, I might buy the put, buy the common stock and then sell the July 95 call that goes out at the end of the day for a buck. I might be able to pick up $1 in premium in the call even as I may lose pocket change on the put. The important thing to understand is that all of this activity does tend to create a balance around the strike, which is why so often things get pinned there. As people are well aware of this pattern, they may have been tempted in the last few days to short a huge number of MSFT July 95 calls for a dollar and change, betting that the calls will go out worthless. Others might have sold those calls months ago to bring in income and never expected the stock to get there. They did not bring them in earlier because they had conviction that they would never have to buy them back. Ultimately, both short-sellers of the calls got the surprise of their lives with the dot-com initiative and then the Bristol decision came down further strengthening the stock. If you had sold the call against the common stock (a buy-write) you might have felt compelled to buy the call back so as not to lose the stock, or have it called away, as we say. If you sold the call naked, well, heaven help you.)

(Remember, short people figured that this stock would not break out.) Some are speculating that MSFT could go still higher, taking the OEX with it. I think that is wishful thinking.

(Wow, was this wrong because soon after we got the Bristol decision and then there was nothing but daylight between Mister Softee and the next strike. However, I think the heads-up helped a lot of our readers, many of whom communicated thanks during the afternoon, except some guy who kept bothering me and should go get a life.)

But it is what people are focusing on, so I am talking about it. I don't like the odds of an OEX ramp into the close. Again, I am an innocent bystander and will not play OEX calls.

(I don't play them because I find them addictive. If you scroll through the archives, you will see how many times I have tried to game where the OEX will go out, and sell calls on a bet they would go out worthless. About two years ago I stopped playing expirations altogether. Now I just wait until Monday to make some money.)

James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. At time of publication, his fund was long Microsoft. His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column at