As stocks split and mergers abound, options owners have more and more questions about how their positions will be treated and where they'll stand after a deal is done. We touch on some of that this week.
We explain why a new option listing won't necessarily put the underlying stock on a roller coaster. We also let one reader know who exactly is buying the option he's trying to dump the day before expiration. Next week is the April options expiration, so watch closely and be careful.
And, of course, keep sending your questions to
firstname.lastname@example.org, and please include your full name.
I am holding a big position in a Nasdaq-listed stock, and it was recently announced that options would begin trading on it. The stock is around 17. My concern is that the availability of options will make it easier to short the stock by buying the calls and shorting the stock while protected by the calls. What do you think? What other impact could options trading have on a stock with average daily trading volume of 100,000 shares, 10 million shares outstanding and a float of 5 million shares? -- Bob Mason
That's a fairly common concern, and because options have been branded as speculative, there's the assumption that the opening of options trading brings volatility to the underlying stock.
Actually, it may seem like it is the case, but professionals say that exactly the opposite happens. "Actually, it should make stocks less volatile because it opens up stabilizing strategies. It gives them a place to hedge," says
Swiss American Securities
options guy Scott Fullman.
Think of it like this: You own that stock at, say, 12. You've enjoyed the ride to 17, expect it to hit 22, but see some short-term bad news muddying your theories. You could dump the stock and try to buy on a pullback. If that idea is common, then there will be volatility in the stock.
With a put option, you can buy some protection for a few months. You buy a put with a strike price of 12 1/2 or 15 and get some protection in case the problems are deeper than you anticipated. That kind of trade doesn't necessarily affect the underlying stock. If that idea becomes common, there may be some pressure from the options market makers adjusting their positions, but essentially it provides core shareholders a way to stay long and have some downside protection.
You could also sell calls and use the premium you take in to balance any loss in the stock position. If you like the stock enough to stick with it, however, you may not want to cap your upside by taking the chance of the options getting assigned and the shares called away from you.
Expiration Fire Sales
Say I bought some calls that fell to near nothing as expiration approaches. They're worth, maybe 1/4. To rescue the little money that's left in them on the next-to-last day, I offer them for sale. I've always thought that they'd never sell -- who wants practically worthless options a day before expiration? But maybe I'm wrong. Is the Options Clearing Corp. obligated to take the other side of the trade if no other buyer is forthcoming -- as it is to guarantee performance of contracts that are exercised (if I'm right about this last point)? -- David Yeidel
You're right about the Options Clearing Corp. Technically, it stands between all public customer trades and the market makers on options exchanges.
More practically, though, when you're dumping your out-of-the-money options the day before expiration, the other side of that trade is most likely a market maker. Market makers typically are short, or sellers, of options. Placed in that position, they're typically more than happy to pay a few cents to guarantee that some type of one-day rally won't leave their short positions decimated.
They'll buy back those cheap options and close out their short positions.
Behind them is the OCC, which serves as a guarantor of all the obligations of options contracts, regardless of the financial condition of the parties.
I own some Microsoft (MSFT) - Get Report 2001 LEAPS I purchased six months ago. Since then, Microsoft has done a 2-for-1 stock split. Do I end up with double the amount of LEAPS or will my current LEAPS adjust in price based on the stock split? -- Wilem Jabbour
On a 2-for-1 stock split, basically nothing happens to affect the value of your position.
That's to say if you own 10 Microsoft 100 calls and the stock splits, your options position is now 20 Microsoft 50 calls. Essentially, all you have to remember is that the dollar value of your position doesn't change.
The situation is exactly the same if you are short the options.
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.