The first official intimation the client receives that his order has been executed is the receipt from his broker of a contract note. This contract note bears the date of the transaction, the name and address of the broker, and the statement that the amount of stock has been bought at the price named. To the amount payable by the client for the stock is added the amount of the broker's commission, called brokerage, and an item comprising the amounts payable for Government stamp duties and for registration in the books of the company. The Government stamp duties are: first, the amount payable on the contract--sixpence on all sums between £5 and £100, 1_s._ from £100 to £500, 2_s._ from £500 to £1000, and so on, according to a sliding scale, up to £1 for transactions exceeding £20,000; and secondly, the tax on the conveyance of ownership, which is at the rate of sixpence for every £5 up to £25; then 2_s._ 6_d._ for each additional £25 or part up to £300; 5_s._ for every additional £50 or part of £50 afterwards. The registration fee is charged by the company for the trouble of registering the name of the buyer in its books, and varies somewhat, but is usually half-a-crown. The contract note also reminds the client that the transaction is subject to the rules, regulations, customs, and usages of the Stock Exchange, and it sets forth the date when the money is payable--the date of the Stock Exchange settlement.
Until the time of settlement arrives, the client enjoys credit. Although he is not really the holder of the stock until he has paid for it at settlement time and received the certificate, he could sell it if the price rose and pocket the profit--by the way, his broker would charge him only one commission, for both buying and selling, if he sold the stock, which he had bought, before the settlement day arrived. The credit might extend over a fortnight if the stock were bought immediately after a settlement, or it might extend for only a day or two if bought immediately before a settlement. At all events, the buyer is in practical possession of the stock for some time before he pays for it, and that is why a broker requires an introduction with proper references, and, perhaps, even security, before he will enter into transactions for an unknown client. Cases have been known of people buying stock and carrying out the bargain faithfully, provided they can sell it at a profit before Settlement day arrives, and thus receive a cheque through the broker; whereas if Settlement day arrives before the price has risen, the buyer has vanished.
Another reason why a broker requires an introduction and references is because of the salutary Stock Exchange rule forbidding him to transact speculative business for any who are not principals without the knowledge of their employers. He may deal for such if they pay cash either with the order or when Settlement day arrives and take up the securities; but he may not aid them in transactions undertaken merely in the hope of snatching a profit by the sale of stocks and shares before they have been paid for. He may not carry over bargains for them from settlement to settlement in a manner which can be explained now that we have arrived at the question of Stock Exchange settlements.
If the client does not desire to carry over, the end of the transaction is promptly brought about. When settlement time arrives, the member who has bought the stock has to pass to the seller, on Ticket or Name day, a ticket bearing the name of the transferee and stating the name of the member who pays for the stock. Reference will be made later to the settlement and its three days. This passing of the ticket is the first step in the completion of the bargain, enabling the seller to see to whom he has to look for the money. If he does not receive the ticket by a certain fixed time--the hour differs in accordance with the nature of the security being transferred--he can have the stock sold out through a special official of the Stock Exchange; that is, he can find another buyer of the stock to replace the one who has not come forward, and the delinquent buyer has to make good the expenses and any loss arising from the process of selling out.
However, the ticket having been passed in the ordinary way, our buyer of Midland Deferred receives from his broker at settlement time a transfer form signed by the seller of the stock. This form, in which the deed of transfer is executed, varies according to the regulations of the particular company whose securities are concerned. But most companies now adopt what is called the common form. The terms of the form are quite simple. The transferor agrees, in consideration of a sum mentioned, to sell to the transferee so much stock or so many shares in the undertaking named, and the transferee agrees to accept them, subject to the conditions on which they were held by the transferor. Both parties have to sign and seal the document. One main object of having the signature of the transferee is, of course, to place on record his acceptance of liability for any uncalled capital which may be attached to the shares. The duty of preparing the transfer form falls upon the seller or his broker, and it may be pointed out that the consideration money named in the deed, as paid by a buyer, is by no means necessarily the price the seller will receive; the stock may have changed hands over and over again at different prices, and the amount mentioned is that paid by the ultimate buyer. It is inserted in the deed because the law requires that the stamp duty shall be assessed on this amount. For the benefit of the seller who may be unaware of the reason why he is required to put his signature to what appears incorrect, a note is usually appended to the ordinary form of transfer explaining this fact.
Having prepared the deed and obtained his client's signature thereto, the selling broker proceeds to hand it, with the seller's stock or share certificate, to the broker of the ultimate buyer, and if these documents are duly delivered on Settling day, or within the ten days' grace allowed thereafter, the buyer is bound by the rules of the Stock Exchange to complete his bargain by handing over the agreed purchase money. But it sometimes happens that a stockholder has a certificate for a larger holding than the amount he is selling, and may not therefore care to part with his certificate. Having sold only part, he prefers not to give up, even temporarily, the whole. In this case, his broker, before parting with the transfer, will forward it with the certificate to the secretary of the company, who will then make a note on the transfer to the effect that a certificate for stock to the amount mentioned in the transfer has been deposited at the company's office, and will forward to the seller a certificate for the balance of his holding. There are, however, some companies which refuse to certify transfers in this way, in which case the duty will be undertaken by the Secretary of the Share and Loan Department of the Stock Exchange, if the original stock certificate is forwarded to the company through him. This certification of a transfer, either by the secretary of the company or by the Secretary of the Share and Loan Department, is by the rules of the Stock Exchange a valid substitute for the certificate itself. Although, as far as the seller is concerned, the formalities just mentioned constitute a valid delivery of the stock, the buyer does not legally possess the stock until his title has been recognised by the company. Having properly signed and sealed the transfer form, the buyer sends it through his broker to the office of the company for registration, with the stock certificate, unless that has already been forwarded. In due course he will receive from the company, through his broker, a stock certificate acknowledging that he has been registered in the books of the company. He is then the holder of the stock he has bought.
CHAPTER VII THE SETTLEMENT
Although in some cases Stock Exchange transactions are done for money and settled by immediate transfer or delivery of securities in exchange for payment, the vast majority of bargains are made for the current account and arranged at the next settlement. The Stock Exchange settlement extends over three days, and at one o'clock on the first of the three--one o'clock in theory, but earlier in practice--the old account ends, and business subsequently transacted falls into the new account. The length of an account is generally about a fortnight, a settlement occurring about the middle of each month and again at the end. But British Government securities and India stocks are not dealt with at the general fortnightly settlement; they have a special settlement of their own, the Consol settlement, occurring once a month, about the beginning.
In the course of each settlement there are three distinct operations, to each of which is devoted one of the three days. The first day is Contango or Making-up day, the second is Ticket or Name day, and the third is Settling or Pay day. For shares dealt with in the Mining Market there is an additional Contango day, on the business day preceding the commencement of the settlement in other securities, making the mining settlement actually extend over four days. If the business day should be a Saturday, then the Friday is the additional Contango day, so that the mining settlement extends over six days.
Contango day is the day on which members, who wish to postpone settlement of their bargains, carry them over to the following account. On the next day, Ticket day or Name day any member who intends taking up registered securities that he has bought during the account, has to hand to the member from whom he made the purchase a ticket bearing the amount and name of the security bought; the name, address, and description of the transferee, that is, the buying member's client, the price, and the date and the name of the member to whom the ticket is issued. This ticket is really a demand for the due delivery of the securities purchased. Now it often happens that the member to whom this ticket is handed is not in possession of the securities he has agreed to deliver, having bought them during the same account from some other member. In this case he endorses his seller's name on the ticket and passes it on. The ticket thus gets handed on from seller to seller until it ultimately reaches the member whose client actually has the securities and intends to deliver them.
This process of passing tickets is greatly facilitated by the operation of the Settlement Department or Clearing House. It is not every member of the Stock Exchange who belongs to the Clearing House, nor is it every security that enjoys the benefit of its operations. But in cases where it can be used, this is the process. On Contango day each member prepares a "clearing sheet" for each security in which he has dealt. This sheet may, of course, show many sales and many purchases, each to or from a different member, but all that the member who has prepared the sheet has to concern himself about--in so far as the securities are concerned, and it should be noted that the Clearing House only clears securities, not money--is the delivery or receipt of the difference between his sales and his purchases; the Clearing House does the rest. If, for instance, a member's sheet shows that he has bought a total of £6,000 of a certain stock, no matter in how many different bargains with different members, and has sold £5,000; then, instead of a separate ticket having to pass through his hands for each separate bargain, the Clearing House discovers from the other sheets some member who has sold £1,000 more than he has bought of the particular stock in question. The passing of the stock is then adjusted by bringing these two members together. The way in which all bargains which come within the Clearing House are cleared off can be easily grasped when it is recognised that for every bargain there are both a buyer and a seller. But the Clearing House has nothing to do with the adjustment of the different prices at which securities are bought and sold. In fact, all bargains dealt with by the Clearing House are passed through the accounts at a fixed price, the "making-up price," and the securities have to be paid for at that price. The settlement of differences has to be arranged in the accounts between member and member, and this brings us to the business of the last day of the settlement, Pay day, the real day of settlement.
On this day all differences have to be paid, and all members who have to deliver securities must be prepared to hand them over in exchange for payment, although in the case of registered securities a further period of ten days is allowed for delivery. Now it is laid down as a rule of the House that all differences must be paid by a cheque on a bank which is a member of the Bankers' Clearing House. By this rule it is secured that every member has both to pay and receive differences at the same time, and the differences which a member receives are directly pledged, as it were, for payment of those he has to give. No grace is allowed for payment of differences, and a member who is unable to meet his engagements is at once declared a defaulter. In the case of the delivery of securities, ten days' grace is allowed after the settlement, as has been mentioned. When a seller has not within the ten days delivered the securities he has sold, the purchaser can have an equal amount of the same securities bought in by an official of the Stock Exchange. This is done by open auction in the House at the lowest price at which the securities are offered. The seller who has failed to complete his bargain has, of course, to bear any expense incurred, and has to pay the difference if the buying-in price exceeds the price of the original bargain. Conversely, as we have seen, when a member who has sold stock does not receive for some reason or other a name into which to transfer it within the appointed time, he may resort to the process of selling out.
This outline of the procedure at a settlement is a general one, and applies to the bulk of Stock Exchange bargains. It has exceptions, however. For instance, securities to bearer are dealt in without any passing of tickets. But the main principles remain the same in all bargains done for the account; and it needs no further explanation to demonstrate how greatly the fixed fortnightly settlement facilitates Stock Exchange transactions. Briefly it means that all sellers of stock agree to deliver on the same day, upon which the buyers are prepared to take it up and pay for it; and that when there have been many dealings between members in the same stock, it is only the balance that has to be transferred.
Bargains in the scrip and securities of a new loan or company are consummated at what is called the "special settlement." Members of the Stock Exchange can buy and sell between themselves and outsiders to their hearts' content, but although there may be mutual arrangement for payment of money and delivery of stock, from the point of view of Stock Exchange law no payment need be made and no shares delivered until the special settlement. The Stock Exchange Committee appoints the special Settling day on the application of members interested in bringing about a completion of the bargains. Before it will fix the day, the company, the bargains in whose shares have to be settled, has to comply with certain formalities to the satisfaction of the Committee. The Committee requires certain documents showing that the company has been incorporated, on what terms the shares have been issued, how many have been issued to the public in proportion to the amount of the company's capital, and so on. It has also to be shown that the share certificates have been issued, or that they are, at least, ready for issue, for obviously it would not do to compel the delivery of and payment for share certificates which have not yet appeared.
The formalities seem simple enough, and yet there is very frequently considerable delay, giving rise to much protest, in the granting of a special settlement. In the majority of cases, this delay seems to arise from the desire of some of those connected with the company to put off the day of reckoning. They may have been buying the shares heavily in order to make the company cut an attractive figure in the public eye at its outset, and may not be over-anxious for the settlement day to arrive before they have had an opportunity of unloading the shares they have bought. At all events, the difference between the long time it takes to obtain a special settlement in the shares of some out-of-the-way mining company, and the short time it takes to obtain one in the case of some great Government loan not subjected to manipulation, is often remarkable. Generally speaking, bargains in the shares of new companies and loans are done for the special settlement, and if no special settlement is granted, these bargains are off; but the instances in which the Stock Exchange Committee refuses a special settlement are very rare indeed. When once a special settlement has been granted and taken place, bargains in the securities are settled at the ordinary Stock Exchange settlements as they occur; in fact, a special settlement is merely a first settlement.
The special settlement is a necessary preliminary to official quotation, the formalities in connection with which are explained in a subsequent chapter. As will be seen, only a small proportion of the securities in which transactions occur are officially quoted, but no official quotation is granted until after the special settlement has taken place.
CHAPTER VIII THE ZOOLOGY OF THE HOUSE
In the discussion of the settlement, mention has been made of those who do not desire to settle as the time comes round. These are mainly Bulls and Bears. To use the time-honoured definition, the Bull is one who buys what he does not want, and the Bear is one who sells what he has not got. The terms were used in their Stock Exchange sense long before the Stock Exchange came into existence--a hundred years before, in fact. At all events, they were in full use when the eighteenth century was in its teens, when dealers in stocks and shares were wandering homelessly about Change Alley. This is shown by the literature of the time. And soon after the middle of the eighteenth century we find Horace Walpole writing to ask a political friend if he knew what a Bull and a Bear and a Lame Duck were. "Nay, nor I either," wrote Walpole, anticipating the answer, "I am only certain they are neither animal nor fowl, but are extremely interested in the new subscription."
Walpole seems to have been a little weak in his Stock Exchange zoology. It was more probably the Stag rather than the Bull or the Bear who was interested in the subscription of the Government loan which he had in hand. It is the Stag who applies for an allotment of a promising new loan when it is issued, in order that he may sell it immediately for a profit. The ordinary applicant who is not a Stag applies for it, of course, to keep as an investment When the loan is likely to be in great demand, the Stag frequently applies for an allotment infinitely larger than he could possibly pay for. He assumes, generally correctly, that he will be allotted only a small proportion of his application and, if he can sell at a premium, the more he is allotted the better he likes it. The existence of the Stag explains the apparent anomaly of a steady decline in the price of a loan soon after it is issued, although at the time of issue the demand was enormously in excess of the supply. A loan may be subscribed thirty times over, and yet within a few months of its issue may be bought in the market at a lower price than that at which it was obtainable by subscription. The fall is caused, of course, by the steady selling of the Stags, who created a fictitious demand.
However, it is easy to answer Horace Walpole's question as to what constitutes a Bull and a Bear. The Bull buys stock that he does not want, in the hope that he will be able to sell it at a higher price before it comes into his possession, pocketing the difference. The Bear sells stock that he has not got, in the hope that he will be able to buy it at a lower price before he has to deliver it. The Bull is optimistic, he believes the price will rise; the Bear is pessimistic, he believes it will fall.
If the advance which the Bull desires has not occurred before the time of settlement arrives, he would be in a quandary but for the organisation which exists in the Stock Exchange to meet his case. Having bought what he does not want, he certainly does not desire to pay for it, and he is enabled, instead of so doing, to continue his bargain. The actual process of arranging this consists in selling out the security and then repurchasing it, both the sale and the repurchase being effected at the "making-up price" already mentioned--it is fixed at each settlement by the Clerk of the House, in accordance with certain rules. In the case of the British Government, Indian, Corporation, and Colonial Government inscribed stocks, it is the average price ruling during certain hours of the settlement; in the case of other securities, it is the actual market price at a defined moment. If the making-up price is lower than that at which the Bull purchased, he has, of course, to pay the difference, besides certain charges, mentioned presently. In the case of the Bear, having sold stock he has not got, he certainly does not desire to deliver it at the settlement, and just like the Bull, he is able to continue his bargain. If, in spite of his desire, the price of the stock has risen, he has to pay the difference between the price at which he bought and the settlement making-up price, and further, to enable him to go on to the next settlement, he has, as it were, to borrow the stock.
It is obvious that a purchaser who carries over his bargain gains considerable advantage by being allowed to defer payment for the security purchased until the following settlement, and for this he has to pay a rate known as "contango." This rate is quite distinct from the difference which he has to pay if the making-up price at which he sold out, in the carrying-over arrangement, is less than the price at which he originally purchased the security. The contango rate is sometimes referred to as a rate of interest, but it is not wholly in the nature of interest; for the carrying over does not consist simply in deferring payment of the purchase money, it also postpones delivery of the stock. Moreover, it sometimes happens that the security is in such short supply, that instead of receiving a rate from the purchaser, the seller is prepared to give some consideration to the purchaser. This consideration, the allowance made by the seller to the purchaser, is known as "backwardation" or "back." If the demand of the buyers for loans to pay for the stock they have bought is balanced by the demand of the sellers for the same stock which they have undertaken to deliver, there is neither a contango rate nor a backwardation rate. Neither buyers nor sellers of that stock have to pay anything for carrying over; the rate is called "even."
Without the Bulls and Bears, life in the Stock Exchange would be a dull affair, for the anxiety that stocks and shares should rise and fall within a short period, before too many rates have been paid, naturally leads to excitement, and undoubtedly causes the promulgation of many rumours and the exaggeration of actual news. The very existence of a big Bull account, or of a big Bear account, naturally has a most important effect upon the market--the former in weakening it, and the latter in strengthening it. Every Bull is, of course, a potential seller, and every Bear a potential buyer. While the Bulls are buying prices may rise, and while the Bears are selling they may fall; but the time comes when their operations, however successful, have to be completed, and the movement in the opposite direction naturally sets in. Good news is frequently followed by a sharp relapse in prices, because of the selling by Bulls anxious to take advantage of it. Bad news is frequently without effect, or followed by a rise, because the Bears see their opportunity of buying back the stock they have sold, and thus support the market. Thus it comes that the rates at the settlement are eagerly watched, that some indication may be obtained as to whether a Bull account or a Bear account exists.
The Bulls may have it all their own way, and by concerted action, called a "Bull campaign," by the dissemination of stories favourably affecting the stock--true, half-true, or untrue--may bring about a "rig." This, however, is a condition of the market the artificiality of which becomes very evident when the time for selling sets in. Unless the delicate position is managed with extreme skill, there will be left after the unloading a residue of Stale Bulls--Bulls who are compelled to close their accounts at a loss. On the other hand, the Bears may have it all their own way. By concerted action they may "bang the market," indulge in a "Bear raid," and bring prices down to a level much lower than is warranted by the intrinsic merits of the security which they have attacked. The talk is all gloom. At the end of the raid, however, the position of the Bear is an exceedingly dangerous one; he may find it impossible to obtain the stock which, having sold, he has undertaken to deliver. Prices begin to rise again, and the "Bear covering," or buying back, only enhances the upward movement. In time it may become impossible to buy back at any price; there is no stock obtainable; the Bears are "cornered." Unless a Bear so situated can make terms with the one to whom he has sold the stock, or with someone who will let him have it, he stands in the position of one who cannot meet his engagements, or, to use another term of Stock Exchange zoology, applied to all members struggling against imminent difficulties, he is a Lame Duck.
CHAPTER IX OPTION DEALING
There is a class of business, in which some freely indulge on the Stock Exchange, which, if transacted cautiously, results in the limitation of losses, whilst providing full scope for Bull and Bear proclivities and a great deal of fascination for the skilful operator. This class of business is called option dealing, and although it is not practised to nearly the same extent as is ordinary speculative buying and selling, perhaps because of its intricacies, the fact that it is full of fascination attracts to it many staunch votaries. There are some jobbers in each market who lay themselves out specially to do option business.
Options are of three kinds. In the case of the put option, the operator buys the right to sell so much stock on a certain day at a certain price; in the case of a call option, the operator buys the right to buy so much stock on a certain day at a certain price; and in the case of a double option, or a put-and-call option, the operator buys the right either to buy or sell so much stock on a certain day at a certain price.
For instance, let us suppose an operator believes that the price of Consols, at the moment 91, is not justified. He thinks it will fall. He decides to indulge in a put option. He buys the right to sell £10,000 worth of the stock at the end of next month at the present price of 73. Believing that it will have fallen by that time, he sees the chance of buying it for less and making a profit by selling it at 73. For the option, the right to sell, he would probably have to pay about 10_s._ per cent. If at the end of next month, when the option has to be declared, Consols have fallen to 71, he can obtain his £10,000 worth for £7,100, and exercise his option to sell them for £7,300, thus making a profit of £200 less the £50 he paid for the option and the broker's commission of about £12 10_s._ The utmost he could lose by the transaction would be the £50 plus commission paid for the option, which he would, of course, not have exercised if the price movement had not been such as to produce a profit. However much the stock might have risen against him, he could not lose more than that £50 plus commission. If in his belief that Consols would fall he had sold them as an ordinary Bear, not taking advantage of the option system, there would, of course, have been no limit to the possible loss, which would have been measured by the extent of the rise of the stock. If it had risen 2 instead of fallen 2, he would have lost, not £50, but £200 besides expenses.