An index based on 24 bank stocks followed by Keefe Bruyette is the second most actively traded sector index on the Philadelphia exchange.
Throughout the day, you'll find Stephen W. Reedy at his post on the floor of the Philadelphia Stock Exchange, taking bets on the future of the banking industry.
Mr. Reedy, who is with O'Connor & Associates, has worked since last August as specialist in the exchange's PHLX/KBW bank index. Composed of a list of 24 bank stocks chosen by Keefe Bruyette & Woods Inc., the index has become an increasingly popular tool for investors hoping to hedge against the banking risks in their portfolios.
Mr. Reedy, who has traded in everything from gold and silver to takeover stocks during a 10-year career, is responsible for making a market for brokers who want to trade in the bank index for their clients.
Easy to Spot
Easily identified by his red hair and the light blue jacket of the firm that employs him, Mr. Reedy is surrounded by the half-dozen traders who make up bank index "crowd." The members of this group and Mr. Reedy compete to sell contracts to brokers.
When the crowd clears at 4 p.m., the floor around him is littered with the day's buy and sell orders.
"At this point it's a successful product," Mr. Reedy said after another busy day last week. "We built the product by showing deep, consistent, liquid markets even in uncertain times.
"In December, for a couple days we were at or above 10,000 contracts traded per day," he said.
No Controversy Here
At a time when derivatives are creating controversy elsewhere in the banking industry, the bank index has become the second most actively traded among six sector indexes on the Philadelphia exchange.
A spokeswoman for the exchange said 319,083 bank index contracts - with a notional value of $9.1 billion - were purchased this year through May. That was a close second to the utility index's 337,000 contracts in the same period.
The average daily volume on the bank index of 3,098 contracts was up from 1,024 in the same period of 1993.
Open interest - representing the number of contracts outstanding - stood at roughly 21,330 at the end of the month. Open interest in the bank index peaked at 35,000 on the third Friday of the month when many of the options expired.
Weighted by Market Cap
The product is based on an index used by Keefe, Bruyette & Woods since 1962. David Berry, director of research at Keefe, said the index, which consists of money-center banks and geograpically dispersed regional companies, has done a good job of reflecting industry trends over the years.
He said the PHLX/KBW bank index is made up of the same 24 banks that Keefe uses internally. But the exchange weights the banks by market capitalization, rather than just using an average of the stocks' prices.
The index, he said, opens a number of investment strategies to the bank investor.
For example, an investor who thinks a particular bank is likely to outperform the rest, but is uncertain about which direction the industry is headed, could buy the individual stock and invest in index options in order to eliminate the market risk.
Thus the investor can "capture the outperform," Mr. Berry said.
Betting on the Industry
Options could also be used to offset the risk of a decline in bank stock prices within a port-folio, he said. Or they could be used to bet on the direction of the industry as a whole, without having to pick individual stocks.
Much of the action on the bank stock index since Mr. Reedy has been on the job has been in put options, reflecting some apprehension on the part of investors about the bank business.
But Mr. Reedy said it was "a testimony to the banking system's strength" that the index did not respond to the recent market correction as much as some feared.
Battle Station
At his station is a computer terminal that lets him keep track of the index and the stocks that compose it. As head specialist at O'Connor, he is required to remain at his post throughout the day, so the computer also enables him to monitor other exchange option activity in order to manage six other traders and 10 clerks who report to him.
Although others in the bank crowd often complete trades, it is Mr. Reedy who keeps the market functioning.
"When a customer asks us for a market, we stand by the market. We take the other side, then use a proprietary hedging system to offset our own risk."
