By Christopher Ebert
If all goes as planned, an exciting new change is coming to option trading beginning March 18, 2013. On that date so-called “mini options” will begin trading for the first time ever.
The options market has undergone some significant changes in the past few years. It wasn’t all that long ago when options were available on a limited number of expiration dates, called the expiration cycle. Typically, for any given stock or ETF, expiration dates were limited to either the first, second or third month of each quarter (e.g. January, April, July and October for a stock on Cycle 1). Choice was very restricted.
Some years ago, expiration dates were extended beyond the current trading year to as far as two years in the future. These long-term option contracts, known as LEAPS, added more flexibility for option traders. However, they were often of little use to the individual retail trader due to a combination of high cost and low liquidity.
More recently the individual trader was treated to a highly-useful new product – the weekly option. Weekly options quickly gained popularity, but some traders were still left on the sidelines. The problem: some stocks and ETFs were just too expensive for an individual trader to justify opening a single contract.
What’s wrong with the current option contracts?
Virtually all option contracts currently control blocks of 100 shares of stock. That is how options have traded since what seems like the beginning of time. One call contract gives the buyer the right to buy 100 shares of stock at a pre-determined price, while one put contract gives the buyer the right to sell 100 shares of stock at a specified price. The problem with the block size being 100 shares is that on stocks with a high share price many traders were simple priced out of the market.
Take Apple Inc. (NASDAQ:AAPL) for example:
One of the most common trades for a retail trader is the covered call. To open a covered call on Apple requires the purchase of 100 shares of stock and the sale of one call option. With the share price near $500, such a trade would require $50,000 in capital in order to purchase the required 100 shares. Although such a purchase might not be a problem for some, for many traders sinking $50,000 into a single trade is just too risky, and for smaller traders it is simply not possible.
Of course, there are other option strategies besides covered call trading. A trader might instead beconsidering buying a call option on Apple.
Using the relatively inexpensive weekly options, such a trader might be able to purchase a call option for $20 per share. But because each contract controls 100 shares of stock, the total cost to purchase that single call would be $2,000. Although $2,000 might be affordable for a small-time trader, the fact that the entire amount can be lost over the course of just 7 days can often represent excessive risk. Consider that if a trader with a $20,000 account made ten such trades and lost, the account would be totally wiped out.
The Introduction of New Mini Option Contracts
Beginning this March, the new mini-options will control 10 shares of stock compared to the current standard of 100 shares. While the minis will not be available on all equities, the initial plan is to make them available on some of the most heavily-traded high-priced products. The most recent list of mini options is as follows:
- SPDR S&P 500 ETF (NYSEARCA:SPY)
- SPDR Gold Trust ETF (NYSEARCA:GLD)
- Apple Inc. (NASDAQ:AAPL)
- Amazon.com, Inc. (NASDAQ:AMZN)
- Google Inc. (NASDAQ:GOOG)
The mini options will trade side by side with the standard options, so there will be no changes for traders using the currently available options. However, the introduction of mini options presents a possible source for errors. Traders will need to pay careful attention to orders from now on. One can imagine the potential damage that could be done by entering an order for five standard call options on Apple (AAPL) when the intent was to enter an order for five mini call options.
The list of mini options has the potential to grow in the future. Stocks or ETFs with a share price of over $100 are potential candidates, so long as they meet the minimum requirement of three-month average option trading volume of at least 45,000 contracts. But the initial list covers some of the most popular products available, so smaller traders will see some immediate benefits.
Taking a look at how the previous examples would be affected using mini options:
A covered call on AAPL would now require the purchase of just 10 shares of stock and the sale of one mini call option. With a share price of $500, such a trade would require $5,000 of capital. That’s certainly a much better choice for smaller traders than the $50,000 required for a standard covered call.
For the purchase of a call option on AAPL:
Assuming that the trader bought a mini call that cost $20 per share, the maximum risk on the trade would be $200. Since the mini contract covers just 10 shares of stock, the risk of loss is much lower than the $2,000 potential loss on a standard call option.
Comparing Options – Apples to Apples
The mini options are not superior to standard options in any way. They are just smaller. The risks are smaller, and the rewards are smaller as well. In fact, there is practically no other difference between mini options and those that are traded currently. Strike prices will be the same, expiration dates will be the same, even the bid and ask prices will reportedly be the same. The only unknown at this point is whether fees might be different, but the current fees are already quite low (typically less than $1 per contract) in comparison to the commission charges that a retail trader might expect. A reduction in those fees on mini options would likely go mostly unnoticed.
What makes mini options attractive is that they will allow traders to take smaller bites. Correct position sizing is a very important to the success of a trader. Mini options will allow all traders to control position sizes more efficiently. A trader with a large account will now have a choice of taking a position size of 100 shares, or 110, 120 etc. using mini options, whereas the previous choice was much more rigid, either 100 shares or 200 shares. A trader with a small account will now have a choice of 10 shares, or 20, 30 etc. using mini options, whereas the previous choice was to either avoid the options altogether or take a 100 share position that was much too large of a risk for the account.
Christopher Ebert, co-author of the book “Show Me Your Options!” and a contributing author to zentrader.ca, often receives questions about options and attempts to personally answer each one. Questions may be entered in the comment box below, or sent to optionscientist@zentrader.ca. Your email address will not be published.
