Opinion as to Validity of “Puts,” “Calls,” &c.
Law Offices of Simon Sterne,
29 William Street,
New York, July 24th, 1886.
H. W. Rosenbaum, Esq., 60 Exchange Place, New York,
Dear Sir:
You ask my opinion as to time contracts known as “puts,” “calls,” and “straddles” or “spreads,” in relation to stocks, bonds, etc. The inquiry is prompted by the apprehension that such contracts may be regarded by the law as of a gambling character, and therefore not enforceable.
Contracts partake of the nature of wagers only when there is no intention either to deliver or to receive the goods, stocks, or bonds, which form the subject matter of the contract. That in point of fact and as a matter of local custom, differences are sometimes paid on the settlement of time contracts instead of delivery being actually made, does not affect the original transaction, and does not invalidate it. So long as there was not a clear intention, either express or implied, that the things themselves were not, under any circumstances, either to be called for or to be delivered, and so long as the holder of the “call” has the right to demand the actual delivery of the stocks or bonds mentioned in the contract, or the holder of the “put” has the right to insist upon the actual delivery of the stocks, bonds or merchandise represented by the “put,” the transaction can, in no sense, be considered a gambling one or partake of the nature of a wager, although, instead of the actual delivery, differences may and sometimes are, as a matter of compromise, accepted for convenience, at the time when the contract is to be enforced.
This practice of paying differences is, as I understand it, much rarer, however, than the actual delivery of the stocks or bonds mentioned in the contract. The courts have of late years, with great uniformity, dealt with these contracts with the disposition to uphold and maintain them, and have discredited the defence of their being of the nature of a wager, and have held the contracting parties to their agreements in the same manner as in every other contract for which a reasonable consideration had passed.
The decision of the Courts of this State, of Massachusetts, Pennsylvania and Illinois, and in the Federal tribunals, where, in one form or another, these contracts have been the subject matter of examination, have been so uniform in that direction that we can now regard this as settled law.
It was only in the infancy of those larger and more complicated mercantile transactions incident upon the development of the modern industrial world, that doubts as to the moral aspect of these contracts could arise. Political science proves, and the law has followed the conclusion, that these time contracts now form a necessary part and perform a conservative function in the economy of a fully developed commercial life. They are an as yet undeveloped form of insurance of values to a purchaser, for which the purchaser pays a fair equivalent, and in process of time such insurances must perform a larger and more important function in the purchase of commodities or of representatives of value which have a tendency to fluctuate largely in price.
For a time it was supposed that the ordinary policy of fire insurance partook of the nature of a bet, and there was doubt as to whether the Courts would enforce contracts of insurance, because it looked as though the insurer was saying to a man who wanted to have his house insured against fire, “I will bet you the value of you house that it does not burn down.” But we have long since departed from this infantile mode of looking at the situation and have learned to regard insurance as one of the conservative elements of modern civilized life, by which heavy losses are evenly distributed instead of coming with crushing effect upon the persons suffering the misfortune.
The capitalist who sells a “put” or a “call” performs precisely the same function as an insurer. He receives an equivalent therefor, and it is a means by which he can turn the securities in his hands with an intermediate profit, without serious risk, except that in the case of a “call” he may be compelled to change the character of his securities, or replace the securities which he has called from him, and in the case of a “put” he may be compelled to re-acquire the securities that he has parted with; but, distributed over a very large mass, and through different classes, of securities, these “calls” and “puts” will balance themselves and leave, if intelligently pursued, a resultant profit to the operator in the “puts” and “calls,” with a prevention of disaster to the purchaser of the privileges, as against excessive fluctuations in the market.
Respectfully yours,
SIMON STERNE.