Does market really need mini-options?
Chris McKhann | firstname.lastname@example.org
Options are all about risk management and transference, and volatility products allow traders and investors to hedge their equity portfolios with a wonderfully inversely related asset. That is at least what the people behind these products want you, and the regulators, to think.
Bloomberg reported recently that exchanges are pushing for smaller option contracts, specifically for high-priced stocks. The examples given are for Apple and Google, where at-the-money calls cost more than $2,000 each.
The smaller options would give the right to buy or sell 10 shares of the underlying stock, as opposed to the current 100. The Securities and Exchange Commission is meeting with the International Securities Exchange and others to discuss the possibility of these smaller denominations.
Part of the rationale is that those who can't afford to buy 100 shares of the underlying stock should have a means of hedging their positions. Apparently "odd lots," or purchases of fewer than 100 shares, make up 77 percent of some brokers' executions.
While the article focuses on the various proposals to make this happen (as all the exchanges apparently favor it), I have to ask if this is really a good idea for the trader.
It is understandable if you can't buy 100 shares of Apple at $570 apiece--that is $57,000 for one position, after all. So the proposed mini-contracts would allow you to buy, say, 10 shares and then one option to protect the position. The total cost would be roughly $5,900, when you include the mini-option.
But those who understand options know that they could simply buy the regular AAPL calls for a total of $2,200 and have essentially the same position as long 100 shares and a long put. If that cost is still too high, you could use a call spread instead to further reduce the outlay and risk. For example, the June 570/590 call spread can be bought for less than $900.
Recent turmoil in some of the VIX-based funds, most notably the VelocityShares 2x VIX Short-Term ETN (TVIX), has shown that not every product out there is a good thing for retail traders and investors, even if they are widely traded with regulatory approval. I think these mini-options may fall into that category.
Options can be a wonderful tool for managing and transferring risk. But what we may need is more education, not more products.
(A version of this article appeared in optionMONSTER's What's the Trade? newsletter of May 9.)