TSC Options Forum: Trading Takeovers and Calculating Costs

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With options becoming an increasingly important tool in the M&A speculation game, this week's forum begins with a question on what happens to options on companies that get taken over or have dramatic changes in their corporate structures. Readers also are interested in finding out more about options trading systems, pricing and some of the essential basics.

This week we called on

Mike Millan

, head of institutional options at the

American Stock Exchange

, to help us answer some of the inquiries. If you've written in and don't see an answer posted, rest assured it is on the way in the next few weeks. And if you've got a question, please email it, with your full name, to

Wade Cook, but as far as trading techniques and "systems" go, follow the age-old saw: If it sounds too good to be true, it probably is.

The

Options Industry Council

recently produced a CD that simulates options trades. It's a big help in learning the essential concepts of options trading. If you want more than that, be sure to stay away from trading programs that advertise only monumental gains. If anyone

really

knew a surefire way to make 2,000% a year trading options, they wouldn't tell anyone.

Basic of Options Volume

What exactly does the volume mean in the options tables? Is it people opening positions, closing positions, or both? -- Joseph J. Cullinan

Joseph,

Options volume is simply the number of contracts traded. That includes opening positions, closing positions and swapping of positions. There are obviously ways to make an educated guess at the situation. If XYZ's February 35 calls have open interest (or the number of contracts outstanding) of 250 and the day's volume is 5,000, it is likely there are 5,000 new contracts in play. But if, for example ABC's daily volume is 5,000 on the Feb. 50 puts and open interest is 17,000, then much of that activity could be traders selling some of those 17,000 options contracts to other traders.

But to be positively sure, you have to wait for the next day when open interest numbers are updated to determine exactly what kind of volume prevailed.

Matching Miscue?

I bought some IOM February calls through my E*Trade account the other day and was able to get all my contracts at the bid. It took all day to fill 50 contracts in three separate buys. E*Trade has mentioned they started an order-matching system within their accounts. Do you think I was filled by another E*Trade seller, and thereby bypassed market makers and got great prices. Since I tend to trade out-of-the-money long shots, it makes a big difference buying at 1/8 or 3/16, etc. What else can you tell us about buying way-out calls/puts? -- Bill Filer

Bill,

We can't comment on E*Trade's policies, but keep in mind a couple of issues. First, all listed options have to be represented on a trading floor. Second, this particular stock trades on more than one exchange (four, to be exact), and it's possible the transaction took place on an exchange that you were not aware of.

Finally, even if E*Trade had an order-matching system, it's highly unlikely that they would assume the risk of not having your order represented on the floor and possibly missing a trade in order to generate the incremental commission from another customer selling 50 contracts, especially if it took all day long.

Odds on Assignment

I have recently written several covered calls to gain income and protect my positions on a couple of stocks I own. Are there any statistics available for percentage of covered calls that get exercised prior to expiration? Is this data somehow available at various strike-price levels versus stock's value? Is it available somehow for individual stocks? I'm interested as a fairly new call writer to get a feel for the likelihood a call might get exercised at various levels. -- Kel Heeth

Kel,

No one really compiles standard statistics for the numbers you're seeking. If you call the

Options Clearing Corp.

, the entity that handles most operational and execution services for the four major options exchanges, some derivative of that information can likely be provided.

Try the OCC's statistics department at (212) 322-6207. They should be able to help.

(Note to readers: Please do not call the OCC for every statistical question you have. Check with your brokerage firm first. It could have the answers right on hand.)

How Short Is Too Short?

Short option margin requirements -- I read the rules but see them through a glass darkly. Could you do an illustration? -- Arthur Dodge

Arthur,

The margin requirements are as follows for a short option position: the premium plus a percentage of the underlying stock (a minimum of 20% but usually 30%) minus any out-of-the-money amount with a 20% minimum. It goes like this: XYZ is trading at 50. You decide to sell (or short) an XYZ 55 call for a $3 premium. Now, 20% of the contract is $1,000 (stock price (50) multiplied by 100 shares, the size of an options contract). After reaching that 20%, add the current price of the options premium (3 x 100), $300. Add the two and you have $1,300. From that number you subtract the out-of-the-money amount, which in this case would be $500 (the 55 call is 5 out-of-the-money with the XYZ share price at 50, and as always in options, multiplied by 100). That brings the grand total to $800.

The alternative formula is figuring out 10% of XYZ's at-the-money option's value plus the premium (again, that would be $800). The brokerage firm chooses whichever formula produces a higher number. The premium, however, is normally placed in the account, so in this case only $500 would have to be deposited.

In addition, many brokerage firms have suitability requirements based on income, equity, experience and sophistication for clients who want to trade options. And remember, these are marked to the market every day.