Are Dropping Stock Prices Causing a Decline in Options Volume?

Citigroup (C) is trading at $5 per share. It is not the only stock below $10. In fact, according to Bespoke Investment Group, the number of Russell 3000 stocks trading below $10 is up to 1,228. A full 42% of the list is below $10. And that was calculated as of Monday’s close.

When the stock is that low, why would anybody buy a call that expires when they can simply buy the stock? I mean, the stock is less than $5. That is much less than Citi’s at-the-money leaps in August 2007 when C shares were $47.

My point isn’t that you should go out and buy the stock because it’s cheap. I wouldn’t touch it with a 10-foot pole. My point is that, once a stock gets below $10, the reason for buying a call diminishes because the stock itself has become a perpetual option. Furthermore the risk in selling a call against the stock in a buy-write also diminishes, as the added protection you get from the covered call is insignificant compared to the loss of opportunity if the stock were to turn around and head higher.

What that means is, as stock prices drift towards these unimaginably low levels, the need for options diminishes. And that has a significant impact on option trading volumes.

Comments

[Urbane Gori...:]

Agree wholeheartedly. Further, with the price of options hitting 25 to 30 percent, it just hasn't been worth it.

But the issue of dropping prices does raise another question: What do the Exchanges do if too many equities drop below $1.00 and there are no available stocks abive $1.00? As I see it they have four choices:

1) Drop the $1.00 limit to 25 cents and give them 6 months to bring their stock price above the new limit.
2) Delist the stock and replace it with a pinksheet or OTC stock.
3) Reduce the size of the index. For example, the S&P500 would become the S&P50! and the Russell 4000 would become the Russell 400! Kind of like a reverse split.

But my favorite is :

4) Allow negative numbers.

jegan ;-)

2008 Nov 21 02:07 PM