If you bought a put for $2.50 then it would cost you $2,500. And if it expired $10 in the money then you would collect $10,000 and have a profit $7,500 after you substracted the amount you paid for the option.

An options buyer can lose only the amount he/she pays for the option. But a seller risks the total amount the underlying stock or contract can move against him.

Ron Patterson

But we are getting far afield. Im not disagreeing with your explanation of intrinsic value or time premium. The main issue I am trying to make clear is not what you or I get when we buy an option as an investment or speculative position, but what happens to the MARKET. (Since youve admitted in this thread that speculators DO impact the energy markets (and HOW recently...;))

The locals in the energy pits at NYMEX do occasionally keep decent size overnight positions for various reasons but most brokers try and go home flat, or as close to flat as possible. If someone comes to buy 10000 crude oil contracts at $70, the local or group of locals who sold those contracts has to buy them back somewhere to hedge, (hopefully lower) - they wont just stay short the 10,000 contracts they just sold to someone! Now, if someone comes in and buys 20,000 contracts worth of $70 strike price call options, this trade has the IDENTICAL impact on market prices, as the local will have to hedge out the mathematical exposure of those calls he just shorted (whose delta makes them worth precisely 10,000 long contracts IN MARKET EXPOSURE).  Traders are constantly monitoring their delta (how sensitive their position is to a move in the underlying) and their gamma( how sensitive their delta is)

Im not talking gain or loss, profit or margin here - just the fact that the options markets can and do move the price of the underlying. As I stated previously, an at the money option purchase will impact the market 1/2 as much as a futures purchase.

I don't think we're in disagreement but in my previous post I justed wanted to point out that hedge funds are not required to register with the SEC and that this means they are subject to very few regulatory controls. I was more or less quoting directly from the SEC's own web site (http://www.sec.gov/answers/hedge.htm):

Unlike mutual funds, however, hedge funds are not required to register with the SEC. This means that hedge funds are subject to very few regulatory controls. ... Historically, most hedge fund managers have not been required to register with the SEC and therefore have not been subject to regular SEC oversight.

There seems to be a subtle distinction, which I admit I don't fully understand, between "hedge funds" and "hedge fund managers" or "hedge fund advisors." However, according to the SEC web site, neither hedge funds nor hedge fund managers/advisors are required to register with the SEC.

I also pointed out that hedge funds must still obey criminal laws, including fraud, misstatement of returns, stealing from customers, etc. I believe this is what you are driving at when you say they are subject to the rules and regulations laid down by the SEC. Indeed, the SEC has prosecuted hedge fund managers for criminal behavior. Quoting again from the SEC web site:

The SEC can take action against a hedge fund that defrauds investors, and we have brought a number of fraud cases involving hedge funds. Commonly in these cases, hedge fund advisers misrepresented their experience and the fund's track record. Other cases were classic "Ponzi schemes," where early investors were paid off to make the scheme look legitimate. In some of the cases we have brought, the hedge funds sent phony account statements to investors to camouflage the fact that their money had been stolen.

But if you are implying that because hedge funds must follow the rules that they are the same as, for example, mutual funds, that is not correct. The differences are primarily, but not exclusively, in the levels of disclosure required from registered investment vehicles versus hedge funds. Here is what the SEC web site has to say:

Hedge fund investors do not receive all of the federal and state law protections that commonly apply to most registered investments. For example, you won't get the same level of disclosures from a hedge fund that you'll get from registered investments. Without the disclosures that the securities laws require for most registered investments, it can be quite difficult to verify representations you may receive from a hedge fund. You should also be aware that, while the SEC may conduct examinations of any hedge fund manager that is registered as an investment adviser under the Investment Advisers Act, the SEC and other securities regulators generally have limited ability to check routinely on hedge fund activities.

The most interesting discussion of this is actually from the  D.C. Circuit Court of Appeals case (Goldstein v. SEC - PDF file). They point out that even the definition of a hedge fund is notoriously difficult to pin down:

"Hedge funds" are notoriously difficult to define. The term appears nowhere in the federal securities laws, and even industry participants do not agree upon a single definition. ... The term is commonly used as a catchall for "any pooled investment vehicle that is privately organized, administered by professional investment managers, and not widely available to the public."

Hedge funds may be defined more precisely by reference to what they are not. The Investment Company Act of 1940, directs the Commission to regulate any issuer of securities that "is or holds itself out as being engaged
primarily . . . in the business of investing, reinvesting, or trading in securities." Although this definition nominally describes hedge funds, most are exempt from the Investment Company Act's coverage because they have one hundred or fewer beneficial owners and do not offer their
securities to the public, or because their investors are all "qualified" high net-worth individuals or institutions. Investment vehicles that remain private and available only to highly sophisticated investors have historically been understood not to present the same dangers to public markets as more widely available investment companies, like mutual funds.

Exemption from regulation under the Investment Company Act allows hedge funds to engage in very different investing behavior than their mutual fund counterparts. While mutual funds, for example, must register with the Commission and disclose their investment positions and financial condition, hedge funds typically remain secretive about their positions and strategies, even to their own investors. The Investment Company Act  places significant restrictions on the types of transactions registered investment companies may undertake. Such companies are, for example, foreclosed from trading on margin or engaging in short sales, and must secure shareholder approval to take on significant debt or invest in certain types of assets, such as real estate or commodities. These transactions are all  core elements of most hedge funds' trading strategies.

The Goldstein v. SEC case writeup goes on and on about what constitutes a hedge fund. If you're interested and have the time, it's a good read.

Sorry about writing such a long post for such a narrow topic.

Do you know where it is?  I printed out the article and lost it, but started reading it and got one page in.  I have been looking for it but can't find it.  Can anyone tell me where this article is?  I really want to read how they are justifying LTCM as worse, although the nominal value are different.  What is a 4 Billion loss in 1996 today?

Going to http://minneapolisfed.org/Research/data/us/calc/
I get it's =$5162523900.57, so this would be about equal or slightly worse.  This is purely based on nominal value, but I understand LTCM was leveraged much higher and didnt have the ability to meet margin calls, whereas there is $3B left of Amaranth.  Also Amaranth was big into future spreads which actually spreads the financial waves throughout the system.  Don't forget in options someone wins at the others expense!