Wouldn't it be great if we could literally create money — not earn, borrow, or steal it but just make some loot out of nothing at all? Governments do that, of course, and sometimes get punished if they do it too much, causing inflation. Banks do it, too, though they pretend that they don't. When banks create money they do so through the extension of credit. Banks typically extend lots more credit than they have deposits to cover. And this credit gets used for more than buying dinners out and filling gas tanks. The boys and girls of the Prediction Company in Santa Fe, New Mexico use computers to trade stocks for their one-and-only customer, UBS, the big Swiss bank, but what they use for money to do all that trading isn't money at all, but credit, an extension of obligation. UBS told those boys and girls to invest as though they had a billion dollars. If they invest well, that's great and UBS enjoys the profits for absolutely no outlay of resources, but if they invest poorly, then UBS is obligated to put up some real money to cover the losses. In this case credit is a financial instrument, a concept we'll get back to in a moment.

If you are rightly wondering why I even care about this stuff it is because I have spent much of the last five years making a documentary about it for PBS. Called "Electric Money," the show will air at 9PM on October 3rd going head-to-head with the mighty "West Wing." Mine is a program about how information technology has changed the world of money. And much of that technology has gone into developing new financial instruments, which are clever tools for leveraging money.

A financial instrument is whipped-up from money (or credit) and time and buyers and sellers mixed in varying amounts and then thrown on the market to see if anyone will go for it. A financial instrument can't survive without people actively trading it. "I'll gladly pay you Tuesday for a hamburger today" is a financial instrument, but only if it produces a hamburger from time to time. So are savings bonds and even lottery tickets. Fifteen years ago in Romania the financial instrument of choice was unopened cartons of Kent cigarettes.

One amazing aspect of financial instruments is that you can invent one, own it, and even get a patent. Governments always did that with currency (they really own it and we just get to use it) but now regular folks can come up with a new idea for a financial instrument, patent it, and anyone who wants to trade that instrument just has to pay up. There are currently about 500 U.S. patents issued for financial instruments. If you buy or sell options on the Standard & Poor's 500 stock index, for example, 10 cents per trade goes to McGraw-Hill, owner of the Standard & Poor's trademark. Now THAT's creating money and finally brings us to the real subject of this column, Vergil Daughtery, inventor of the Expirationless American Option or XPO, which just this week received its third patent.

Vergil lives in the mountains of North Carolina where he works for a nonprofit agency that sets up group homes for disabled people and that is part of the wonder of this story. Not only can you invent a new way of doing business and effectively control that new way from a lakeside in North Carolina, you don't have to be some snobby Harvard or Stanford Ph.D. to do it. Vergil, who works for a nonprofit because they don't demand to own his ideas like a Wall Street firm would, has bachelor's and master's degrees from Georgia Tech.

That's nice, but what is so special about this expirationless option? For one thing, while there have been some academic papers about "perpetual options," nobody else seems to have ever thought to actually give it a try in the real world. For those who aren't familiar with them, options are financial instruments that grant the right (but not the obligation) to buy or sell some security or commodity. European options grant the right to buy or sell on the last day of the option period while American options grant the right to buy or sell at any time between now and the end of the option period. Vergil's invention, the Expirationless American Option is yet a further extension — an option to buy or sell anytime between now and the end of creation. Simple? No.

"I came up with the idea at Georgia Tech," said Vergil. "We were studying the Black-Scholes option pricing model, which is based in part on some work done by another economist, Robert Merton, and I just couldn't understand why there always had to be a time component in the model." Certainly the tradition of commodity option trading was based on seasonal crops, so periodicity was a natural factor there, but there seems to be no reason why other types of options have to have a fixed lifespan. "If you had an expirationless option, it would be like a single-premium insurance policy for financial risk — simpler and with lower risk than traditional options, futures or margin positions because it has no expiration date."

To some people, XPOs are like dyeing your dog's fur then claiming it is a whole new breed: they are nothing to get excited about. But other people are excited about XPOs and for good reason. Vergil has done a good job of creating the playing field, for one. XPOs have the blessing of both the Internal Revenue Service and the U.S. Securities and Exchange Commission. But even more importantly, XPOs accomplish something for the people who choose to buy and sell them. They supply both liquidity and a tax advantage.

Because they have no expiration date, XPOs are much more versatile than regular options. Say Cisco Systems stock is selling for $24 and you are sitting on a lot of shares that you unfortunately bought at $40. You can sell an XPO that gives someone the right to buy your Cisco shares at $40 or even $60. Such a sale would be difficult if the option had to be exercised in 3, 6, 9, or 12 months, but what are the chances that Cisco will EVER get back to $40 or $60 per share? Those chances are pretty good, which is why XPO buyers are likely to be easier to find than traditional option buyers once the new instrument comes to be understood. With XPOs, you'll be able to simultaneously sell Cisco puts (options to sell) at $18 and Cisco calls (options to buy) at $30. No matter which direction the price heads, you are covered. In the meantime you have taken some money out of shares that were worth less than you originally paid for them without really touching the underlying stock. And under IRS rule 312b, the transaction is not taxable until the position is finally closed by someone actually exercising or reselling the option. This means that for now the XPO proceeds are a tax-free, interest-free loan.

XPOs won't let you avoid tax, but they will give you a lot more control over when a tax obligation is considered to be due.

Let's look at a second example where Microsoft is the seller of XPOs. Microsoft holds lots of shares in other companies — shares that often contribute nothing at all to Microsoft earnings either because they have gone down in price or because they pay no dividend. But what if Microsoft sold XPOs on those non-income-producing shares then used XPO proceeds to buy T-Bills — short-term securities sold by the U.S. Treasury? Those XPO's would be generating what is effectively a dividend from non-dividend-producing shares. And because of IRS rule 312b, that T-Bill purchase can be seen as an integral part of the financial instrument, which means that at least for a while those "dividends" also go untaxed, which regular dividends would not.

So XPOs might (or might not) be the NEXT BIG THING in financial engineering. The last big thing — the Black-Scholes-Merton option pricing model, circa 1973 — spawned the whole financial engineering industry and is today a trillion dollar market. But unlike B, S, & M, young Vergil owns XPOs outright and stands to earn a tiny royalty on every transaction. He's cutting deals right now with investment banks and financial exchanges. Heck, this thing might actually work. And if it does, it will have taken one man only ten years, three patents, and knocking on countless doors to create money out of nothing at all.

As always, I have no financial stake in XPOs or much of anything else except my burdensome mortgage. Oh, and there are some interesting links under the Links of the Week.