When a corporation needs capital, it has the choice of
borrowing the money or issuing shares.  The trading aspects of
existing shares is the subject of my discussion.  The particulars
related to a new issue (such as who handles it, how is each share
priced, etc.) will not be considered here.

Trading shares on the stock market is a “two way auction.”
In an auction, two or more buyers bid against each other to
purchase the object auctioned; the eventual sale price is driven
in one direction – higher.  In a bidding for a block of shares
the stock price is pulled in two directions, the seller wants the
highest price possible, the buyer the lowest price possible.  In
other words, the price of the shares of a given corporation is
“floating,” it can differ from day to day or even from hour to
hour.  This is problematic and a better way (in keeping with the
spirit of the free market) should be devised.  Why is it
problematic?  Let us look at three examples.

Options

An option is the legal right to engage in a specific
purchase or sale at a stated price within a given time frame.
Let us look, and contrast, two situations, one in stocks and the
other in real estate.

Let us assume that the stock of ABC corporation is presently
$50 a share.  Let us further assume that you pay someone $500 for
the right to purchase 100 shares of that stock from him at that
price ($50) anytime within the next three months.  If, at a point
in time, within the next three months the price of the stock goes
up to $70, you can decide to exercise your option, giving the
other investor $5,000 (100 shares x original price of $50 a
share).  You can then sell them on the open market for $7,000
(100 x $70).  Your profit on this transaction will be:  $7,000
less the original purchase price of $5,000 less the $500 you paid
for the option = $1,500.  (Commissions and interest, if you
borrowed the money, were ignored in this example).  If we now
assume that the price has stayed at $50 or gone down during the
three months, your option would be worthless, and your loss would
be $500 or 100% of your investment.  (Options are securities in
their own right, they are commonly traded by themselves).

Let us assume that a tract of land is up for sale for
$50,000.  Let us further assume that you’re interested in buying
it, but haven’t made up your mind.  You offer the seller an
option to buy the land at the present price ($50,000) anytime
during the next three months, for that privilege you pay him
$2,000.  He agrees, and that means that for the next three
months, he cannot accept offers from other potential buyers.  At
the end of three months you decide not to buy the land and lose
the $2,000 you paid the seller.

Real estate options are bought to keep someone else from
getting a given property, therefore they play a useful role, even
if the option is not exercised and the potential buyer loses his
investment.  The usual reason for buying or selling stock options
is to make money.  There is, of course, nothing wrong in making
money; we invest money, and accept the risks, to make money;
however, in this case, we make money as in gambling.  Investors
bet on the outcome of a future event (the future price of a given
stock) and can get hurt.  In fact, it’s been estimated that 80% –
90% of nonprofessional futures and options traders lose money.
(Futures are not discussed here).

The existence of a floating price for shares is what permits
stock options to exist.  I realize that the replacement of
floating prices is a new idea; it is open for debate, but before
we start the debate, let us look at two more examples.

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