TSC Options Forum: An Effective January

The column on the January Effect triggered a wide range of questions. Even though the window of opportunity is closing, we still have a few days left to explore the best way to take advantage of the seasonal rally in small-cap stocks.

Steve, Do the iShares have a Web site, or do you have a link to a Web site for all their ETFs? Does one exist?

--T.S.

Because the article suggested buying calls on the Russell 2000 iShares ( IWM), understanding the concept, construction and offerings of the exchange traded funds known as iShares seems like a great place to start. By going to the Barclay's iShares Web site you can learn all about their products and myriad offerings, some 98 at last count, including broad-based indices, narrow sector and foreign, and bond-based funds. For example, you might decide that buying the iShares Russell 2000 Growth Index Fund ( IWO) or its options offers a better opportunity than the iShares Russell 2000 Value Index Fund ( IWN).

(This is probably a good time to remind everyone to be very careful and double-check all ticker symbols before entering an order. Make sure you understand what you are trading, and that what you are trading is what you intended on trading. Is that clear?)

Steve,

I saw a quote that read IWT JAN 107 CALL Dec 24 close: 4.20-4.60 Last 3.60 Vol: 0 Open interest: 2351. What does open interest mean? Any reason why this particular call has not traded over the last couple of days?

-- G

Regarding open interest, let me quote myself from a previous article. "Open interest reflects all transactions, spreads or otherwise. There's no distinction between a sale and purchase because both are needed to consummate a trade. Unlike stocks, which have a finite number of shares available, option open interest is unlimited. It's also a zero-sum game (also unlike stocks, where the overall value can rise or fall as the share price and market cap changes) in which the dollar amounts net out at expiration -- some people win, some lose. Here's an article in which I discuss some issues regarding open interest and what it may or may not be telling you.

This past Wednesday was a holiday-shortened session, and IWM, whose options trade under the IWT symbol, only traded about 350 contracts across all strikes on the day. This was about 50% of the average daily volume. Maybe this next email will helps explain why less liquid issues can sometimes have days go by without a contract trading.

Steve, IWTAC calls: You nailed this one. All I got was an unfilled order under the market on Dec. 17. Could have bought at $2.70 and sold at $4.40 this a.m. Makes your 70% calculation eerily accurate. Way to go. Next time I might not be so stingy.

-- R.J.

While you know the rules against should've, would've, could've ... don't feel bad about not getting filled on an option order. One of the hardest parts of trading options in thinly traded series is literally getting the trade off. As the reader above notes, the bid/ask spread on this call can be as wide as 40 cents. This represents a 9.3% differential on a $4.30 item.

This is a huge amount to "give away," especially if it needs to be done on both the buy and sell side of the trade, and creates a tremendous headwind for generating profits. So, don't feel bad about not stepping into the breach; don't be discouraged, stick with limit orders and let the market come to you. Taking a conservative and value-oriented approach will serve you well over time.

Which brings us to the final, and most oft-asked, question of the year,

Steve, does the little guy have a chance to make money trading options?

-- F

Yes. Definitely. Without question. But only if you're really, really right.

Thanks to everyone for all the great questions and feedback. Until we speak again, I wish you all good luck and may all your winners be filled.

Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to Steve Smith.

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