Every Penny Counts

This column was originally published on RealMoney on Feb. 22 at 3:24 p.m. EST. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

The rollout of the Penny-Trading Pilot Program, which will allow options to be quoted and entered in 1-cent increments, was completed when two exchange-traded funds, the Nasdaq 100 Trust (QQQQ) and Russell 2000 iShares (IWM), were added last week. This rounds out the 13-name list that will constitute what is supposed to be a three-month trial period.

But the glitch-free transition and positive feedback pretty much ensure that trading options in pennies is not only here to stay, but will eventually expand to the majority of listings. The impact is already measurable, and traders are quickly taking advantage of the tighter markets.

The average daily trading volume of the equity issues -- which includes, General Electric (GE), Whole Foods (WFMI) and Caterpillar (CAT) -- has seen a 9% increase on average since the launch. For the two ETFs, the volume increase has been about 2%, but considering that the QQQQs and IWM had averaged over 100,000 contract a day, this still a substantial increase of some 20,000 contracts.

The increase in volume is probably the result of several factors, but all stem from the tighter bid/ask quoted in the market, many of which have narrowed down to one and two cents for the active strike prices. "A tight market invites trading activity, especially among active professionals for whom every penny counts," says Alan Wickoff, chief strategist at Bal-Wick Capital, a New York based hedge fund.

Indeed, there have always been stocks that traders gravitate to even if they are not among the most "important" in terms market leadership, or even best performers. Throughout the 1990s, Micron(MU) tended to be a trader's stock, and its options often logged more volume than peers such as Intel(INTC) or Applied Materials(AMAT), whose technology and business dominated the semiconductor space.

For active option traders, the tighter markets remove some execution risk, such as slippage or trying to leg into a position, and reduces costs. Multileg or spread orders now get scooped up and filled quicker and at better prices.