Mini-Options: A Crash Course for Options Traders

optionsguy posted on 03/13/13 at 12:26 PM




Trading options on high-priced stocks just became more affordable for individual investors. On March 18th, mini options will be introduced on Amazon (AMZN), Apple (AAPL), Google (GOOG) and a few other, high-priced underlyings. If volume in this product grows, we expect to see additional mini-options issued in the coming months.

Instead of the standard option, which represents 100 shares of the underlying stock, a mini-option stands for only 10 shares of that stock. The rights and obligations of the mini contract are the same as the standard contract in every other way.

What does that difference mean to traders like you? Since the number of shares the contract represents is small, the cost of entry is much lower for you versus standard options, because the number of shares the contract represents is the multiplier used to determine the total cost for the trade. For example, if you received a quote of $12.00 on a “big” 100-share contract, the cost of that standard option would be $12 x 100 or $1,200 (plus $5.60 in commissions at TradeKing). If there was a “mini” contract available with the same quote, the cost would be $12.00 x 10 or $120, plus $5.60 in commissions.

Here are a few more positives and negatives of mini-options to consider before trading them:

Positives:

1)  Covered calls on expensive stocks will be more doable with minis.

To employ a covered call strategy, previously investors had to own at least 100 shares of a stock to sell a call against their stock position and it be considered covered. That would be very capital-intensive if the stock is trading north of $400 per share. Mini-options will allow the flexibility to sell a covered call on as little as a 10 share position on these expensive stocks.

For instance, to sell a covered call on Apple would require about $43,000, the approximate cost of 100 shares of Apple stock (obviously depending on where the price is, for this example, AAPL is at $430 per share). Now with AAPL mini options you can sell a covered call against a position of only 10 shares of Apple, which requires just $4,300 in available capital – quite a bit more plausible. (Learn more about covered calls, including the risks involved, at our sister site OptionsPlaybook.com.)


2) Mini-options potentially offer traders more flexibility.

The availability of mini options on an underlying stock will allow traders the ability to scale in and out of positions. For example if you were planning to buy one standard option contract, you might opt to buy a 10-lot of minis instead. Why? The total number of underlying shares represented would be the same - 100 in each case. But if the market were to move in your favor, mini-options would allow you to sell half the position and keep the other half to see what happens next. The same holds true in reverse: if the market moved against your position, you could reduce your risk by exiting half the position and remain long the rest in case the market bounces back. Note that the 10-lot mini scenario would come with increased commission costs, but some might figure the extra cost is worth the flexibility upon exiting the trade.


3) Lastly, in general it’s better to have more choices versus less.

More choices are arguably better than less, and mini options will add diversity to the diversifying security type. In line with the covered call example above, the ability to enter more, different option positions could open the door to diversify smaller portfolios. In this regard, choice can be better. Of course, that may not always be the case, and keep reading for more thoughts on this.


Now for a few negatives of mini-options:

1) There will inevitably be a learning curve.

Individual investors (who don’t read the options guy blog, that is) may have some initial confusion about the total trading costs, not to mention other adjustments to your trading approach. That goes with the territory for any new trading instrument, however.


2) Commissions will most likely be a bigger part of the overall cost.

TradeKing will charge the same commission for mini options as for standard options: $4.95 per trade, plus 65 cents per contract. But that $4.95 commission will represent a larger percentage of the principal amount of the trade. (That’s always been true for equity trading here, too: We charge $4.95 to buy 100 shares of AAPL, just like we charge $4.95 to buy ten shares, or 1 share. Similarly, our price doesn’t change if you are buying a $4.00 stock or a $400 stock, a 10-cent option or a $5.00 option.)


3) Mini-option position value will respond more slowly to changes in the options price.

The expectations are that “minis” will have the same quoted price as “big” option contracts. For example, if on a specific stock a “big” option is quoted at $7.25, the mini option with the same strike and expiration in theory should also quote at $7.25 (all other factors being equal).

However, if both options increase in price in tandem by $1.00, a one-lot “big” option position would increase by $100 and the one-lot mini position would only increase by $10. Bottom line: 1/10 of the cost to enter a position will also means a 1/10 of the movement will be gained or lost when the option contract changes in price.


4) What if there are stock splits?

Stock splits will make mini-options on those stocks that much more more confusing. Several of the underlying stocks chosen for the mini’s debut have split in the past. If a split were to happen again, the result will be some even harder-to-understand adjusted mini option contracts. FYI: Apple has declared three 2-for-1 splits during its publicly traded life: June 1987, June 2000, and February 2005.  

Amazon (AMZN) hasn’t split in over a decade, so whether it’s likely to do so now is open to debate. (Here’s a brief history of AMZN stock splits.)

According to The Boston Globe, Google recently proposed a stock split, too, but it was put on hold until Google resolves a shareholder lawsuit alleging the stock split would unfairly cede too much power to Larry Page and co-founder Sergey Brin, the company’s largest shareholders since its inception. A trial is scheduled to begin June 17 in Delaware.

Granted, the quirky options produced by stock splits only hang around the markets for so long. Eventually they expire and cycle out of existence, but that does not help if you had a position on before the split and wake up to find yourself with an “interesting” new position in your account. It’s not a show-stopper issue, but it will be a complicating factor in this new product’s comprehensibility to traders.


5) Mini options may complicate your choices as an options trader.

Today, if you pull up an options chain for Apple – say 430 calls expiring in March – you’ll get one standard option that matches those criteria. Once mini-options launch, that same search will yield you at least two choices: a mini- and a standard-sized option. If there happens to be a stock split issued that impacts this option, you could wind up choosing from four different options: a “big”, a “mini”, a split-adjusted “big”, and a split-adjusted “mini”. Too much choice can be off-putting to traders, plus it incurs heavier costs for data burdens at brokerages.


Of course, as with any new trading product there are unknowns that will only be sorted out when trading starts. Here are a few we’ll be watching at TradeKing:

1) Will the bid/ask spreads for mini options be as narrow as the bigger contract?

Another way to ask this is: will they be as liquid as the standard-lot contract? Illiquid positions are, by definition, hard to exit without encountering a potentially unfavorable change in price. Only time will tell...


2) Large lots - will anybody trade more than 10 mini contracts?

For a new product to gain true, lasting market traction, it has to historically had to demonstrate the power to attract institutional traders as well as individuals. Large lots are the chief indicator that institutions are joining the game and adding to the liquidity of the market.

Additional food for thought:

Another “mini” concept was introduced awhile back by the Chicago Board Options Exchange (CBOE). The exchange introduced  a mini version of  S&P 500 Index (SPX) and they appropriately named it the Mini-SPX index (XSP). Mini-SPX index has 1/10th of the value of the S&P 500 (SPX) Index. In other words, if the S&P 500 Index is at 1,550.80, the Mini-SPX index would have a value of 155.08. They chose to adjust the value of the underlying in this case and keep the multiplier of the option contracts at 100.  I personally would have voted for changing the underlying value vs the changing the contract size. If you find the current incarnation of “minis” confusing at times, you know why I would vote that way. ;-)

I’d love to hear your questions, comments or input as you dive into these new securities. Watch this space for more education on mini-options, presuming trading volume takes off and a sustainable market emerges. Until then, happy trading to you!


Regards,

Brian Overby
TradeKing Options Guy and Senior Option Analyst 
www.tradeking.com

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Posted by optionsguy on 03/13/13 at 12:26 PM

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