One of the biggest problems small investors face, for example those who put $5000 or less each year into an Independent Retirement Account (IRA) is that it is discouraging to buy stocks in the IRA funding season in the springtime and immediately see them drop below the purchase price and go steadily southwards for months to come.
One way to mitigate this effect is to use options to reduce the cost of purchase and reduce potential downside losses. However, options are usually only sold on round lots of 100 shares and with some stocks, that can work out to be very expensive. For example if you want to sell a call to cover 100 shares of Google (GOOG), first you need to buy 100 shares of Google for $80,900. Yikes! Even if you have that cash in your account, do you really want that much money in just one stock?
Wouldn't it be nice if you could sell a covered call on just 10 shares. If you then sold an at the money 2015 call, you could get the job done with less than $7,000 of free cash in your account.
Well, now you can do just that.
The Chicago Board of Exchange on Monday March 25th launched a series of mini options that trade just like standard options, but each mini options contract represents just 10 shares of the underlying stock instead of the 100 shares in a standard options contract.
All of these stocks trade for over $100 per share and the idea is to give smaller investors the opportunity to use various option strategies without having to put up large amounts of capital as collateral.
Here's some mini options FAQ information from my brokerage (courtesy of TradeKing):
Question: How are mini options different from regular options?
- Trading symbols for Mini Options will also differ with a suffix of "7" (i.e., "AAPL7" or "SPY7").
- Mini Options carry a deliverable of 10 shares as well as a multiple for premiums of 10 (1/10th of the standard option).
- Total Value per Mini Options Contract is 1/10 of the standard contract with the same strike and expiration (option price x 10 for Mini Options versus option price x 100 for standard options).
- Total Value of Deliverable per mini contract is 1/10 of the standard contract with the same strike and expiration (strike x 10 for Mini Options versus strike x 100 for standard options).
- Like their standard counterpart, Mini Options will have a Last Trading Day (last business day prior to expiration (normally a Friday) as well as "American" exercise style (Exercisable any business day prior to expiration).
Question: What option pairings/strategies are allowed with Mini Options?
This brokerage will support all strategies currently allowed on standard options.
Given your account has the appropriate option approval level and the funds required for such trades, these strategies include:
- Covered Calls (10 long shares and 1 short call)
- Iron condors
Note: All strategies where multiple option legs are involved must all be Mini Options. This brokerage will initially NOT support cross pairings between standard and Mini Options contracts.
So what will the effect of the new mini-options be? The possibility of Apple splitting its stock, perhaps by 10:1 to make ownership easier for small investors has often been discussed in Seeking Alpha.
One viewpoint is that it would make no difference, since any investor can buy as little as one share for about $450. Another view is that it would encourage more small investors since hedging strategies using options would be available at a much lower level.
Apple, manufacturer of the iPhone, iPad and other popular products is a very popular stock that has made many individuals wealthy as it rose from about $10 per share at the start of the millennium to over $700 per share in September 2012 and then plunged spectacularly over the next few months, ducking below $420 per share after a lackluster January earnings report.
Currently trading around $460 per share, the company remains a massive cash cow and the stock still looks cheap by most metrics with a price to earnings ratio of 10.47 and a massive $150 billion or so sitting in banks around the world--enough money to buy out almost any other company in the world.
100 shares of Apple would cost more than $46,000 at today's price, putting it well beyond the reach of many investors, but a 10 share lot would cost only $4,600. WIth the new mini options investors who own as little as 10 shares can sell covered calls and use other option plays to hedge their position.
It looks to me that the April 26th Apple calls have enhanced implied volatility that makes them more expensive due to an impending earnings announcement and I could sell a slightly in the money call for something like $20 per share. If I buy 10 shares of AAPL for $4,650 and sell an April 26th call with a $460 price strike for $20 per share, what are the possibilities?
1) The stock holds $460 on option expiration and my shares are called away for a profit of $15 per share or $150 in one month. In the example given, that would mean a return of $150 on net $9,100 outlay, which represents an annualized rate of about 20%. Not bad.
2) The stock fails to hold $460 on expiration, and the short call expires worthless. I am now in possession of 10 shares of AAPL at a net cost of $445. If the price is not too low, I can now sell perhaps a $440 call around the next earnings date that will again eventually either lead to my shares being called away at a profit, or else will lower my basis on the original shares.
The advantage of buying into AAPL like this is that if the stock falls one can continue to build a position by slowly increasing the number of shares owned and lowering the net basis or else if the stock moves up one's stock is called away at a profit.
Alternatively, I may decide to acquire my AAPL stock by selling puts first. I could sell a weekly mini-option put at the money for about $5 per share. Let's see how that would work out.
1) If the stock holds $465 that would give me $50 at the end of the week (minus brokerage fees). In a cash account or IRA this put trade would require $4,600 in cash so the $50 return would be represent over 50% annualized. Wow!
2) If the stock does not hold $465 on expiration of the option, then I am assigned 10 shares of AAPL at a net cost of $460 and I can now sell a covered call with a strike price of $460 and sell another put to try to get some more shares for even less and average down my acquisition.
To see how this might work out, I started a small AAPL mini-option portfolio put this into practice. I bought 20 shares of AAPL for $465 each, sold 2 April 26th calls with a strike price of $460, and sold 2 weekly puts with a strike price of $465. Here they are displayed in my brokerage account.
This trade was done in something of a rush and is less than ideal, but in my next article I intend to come back to these trades and see what mistakes were made and how they could have been tweaked for better results.
In my opinion these mini-options will be wildly popular with smaller investors, not only as a way of building a position in a stock like Apple, Amazon, or Google, but also because they open up a number of options strategies that involve scaling in and doubling up that were previously prohibitively expensive (and risky) for smaller investors. Probably they should be taken as a bullish indicator for the non ETF stocks concerned, though whether the volume will be sufficient to move the needle remains to be seen.
Caveat: At the present time--on only the second day of trading--the mini-option spreads (the difference between the bid and offer prices) of these options is high due to limited liquidity (supply and demand), but if they become popular that may soon change. For that reason covered calls, also known as buy-writes, may be the most economical choice.
Additional disclosure: Although I am currently long AAPL and expect to remain so, I hold shares, long options, and short options and may change the overall balance to make the position longer or shorter at any time depending on variables such as trading conditions, earnings announcements, natural disasters, and so on.