We won't stand on ceremony with a long lead-in. Instead, we'll jump right in. This week's column addresses when the best time is to, well, jump in and sell your options, how traders cover themselves (or their eyes) when their clients sell "naked" options and the difference between European and American options.
And don't forget: Keep sending your questions, along with your full name, to
Expiring Options by the Numbers
On average, what percentage of options expires out of the money? I have been told it is around 65%. -- Jonathan London
First of all, this question probably refers to call options; a call option is said to be out of the money if the stock is selling below the striking price of the option. For example, XYZ stock is trading at 47. The XYZ August 50 call option is out of the money, just like the October 50 or even the October 60 call. However, the August 45 call is in the money.
The out-of-the-money percentage is widely watched. Like clockwork, the
Chicago Board Options Exchange
calls for this number from the
Options Clearing Corp.
every month, and the OCC computes it for each exchange. The percentage for June was 57.8%. In April it was 65%.
Why is it an important figure? "People focus on it, either to say that options are bad, or to say 'I told you so -- they mostly expire worthless,'" explains Dave Gray with the CBOE. "But remember, part of the reason to buy an option is as insurance. And if you're a writer of an option, you
it to expire worthless. It's another one of those indicators that can't stand alone, and it should be taken with a grain of salt."
Liquidity to Spare
I am a beginner who trades generally fewer than 10 contracts per long put and call trade. Is there a volume or liquidity threshold that can serve as a guiding measure to anticipate the probability of closing a trade on a timely basis, say, intraday, after capturing a short-lived momentum move? For example, the daily trading volume and open interest on any given day in some America Online (AOL) options are quite high. But for lesser-traded options, other than selling into rallies, do I have to wait for the option exchanges to match my close order? Or based on my small, 10-contract open, do I more automatically (based on my type of order, market or limit) get closed without the matching from a third party? -- Peter Melnikoff
The simple answer is, when you're dealing in 10 lots, there's just no liquidity issue.
"You don't get that until you're doing 1,000 lots," explains George Fontanills, president of
Pinnacle Investments of America
in Boston and an options specialist.
"I get that question a lot at my seminars," Fontanills says, adding that a lot of people think 10 lots or 100 lots will present liquidity problems. "So in essence, there's nothing to wait for. When he puts in a market order, the exchange isn't the other party. It's either the specialist or the market maker. They'll be able to find the third party."
Besides, he adds, there's enough volume in any AOL strike price to handle the order. "When he wants out at the market price, he'll get out," says Fontanills.
When I buy or sell a "naked" option, how does the trader cover his risk? The answer would be very helpful to individual investors in options in terms of managing risk. -- Kamel Zaki
"Read my book,
The Options Course
," urges Fontanills. (Well, you don't have to, because he's going to tell you here.) "I tell people
to do naked options."
Naked, by the way, means streaking across the trading floor with no clothes on. But selling naked puts and calls means selling the option without owning the underlying stock.
"It's the worst strategy in the world, because you have to put up too much money. Plus, it depends on the margin requirements of the brokerage, but in many cases there's a $25,000 minimum to do so. If you want to make $300 on a naked trade, that's not a very good return," he adds. No joke this time.
There's always a better way, Fontanills says. Try this: a bear call spread. "It's covered and similar to a naked trade. It's selling a lower-strike call and buying a higher-strike call above it. Sell an AOL 105 call naked, but don't do it unless you buy an AOL 110 call. The difference between the strikes is the most you can lose, minus your credit -- the amount you take in for selling the option. You put up less money and it's smarter." Thanks, George.
Are there European-style index options readily available for individual retail investors? Sounds like a very cheap way to insure your portfolio. -- Norman Pan
The difference between American and European-style options is that the American variety can be exercised at any time, European only at expiration.
European-style options traded on the CBOE are usually index options, according to the CBOE's Gray. "Most single-stock options that are traded are American style. Traditionally, index options are used to hedge portfolios. The most popular for retail investors are the
, the SPX, and the
, the NDX. But remember, the trader can't exercise until expiration."
TSC Options Forum aims to provide general securities information. Under no circumstances does the information in this column represent a recommendation to buy or sell securities.
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