At Option Pit Mentoring we are always trying to keep our option mentoring students up to date. Well.....If option traders didn’t have enough on their plate already, I have some great new for all to you. The option exchanges began listing half strike options in Citigroup today. I understand the logic, and think it is probably a good idea. I am going to lay out a few of the positives and negatives. Then I will ask whether this was the right product to roll .50 strikes in.
The primary thing I like is that .5 strikes will allow trader to put on collars that will actually protect a large stock position. Until now if someone wanted to collar up C, they could collar 3 dollars and 5 dollars, problematic because most people don't like to take 25% losers before the collar kicks in. The other option was to buy the 4 dollar put and get .01 or .02 by selling the 5 dollar call. At .01 or .02, the trader would probably be better off simply having the protective put on.
Now that C has .5 strikes traders will be able to collar a large stock buy and actually
1. Receive real protection with stops at .12.5% below and above 4.00
2. Not pay a lot for that protection
3. Set up collars against 4 dollars that actually reduce the price of the put
I also like that trades will be able to spread option trades off of one another and receive true cost reduction. For instance, in the past if customers wanted to buy a call spread, sell put spreads, or even bullish time spreads or bearish time spreads customers really didn't have many options. For instance, if I wanted to buy a call spread in C. Until today I would have to have bought the 4/5 spread. Even in December, the 5 calls are only 2.00 bid (less than many traders’ commissions. I would have had to go to Jun 2012 before I got any real value out of the selling the 5 calls. If a trader thinks a short term pop will happen June is a little long dated. Now that I can buy the Dec 4/4.5 call spread, I can get a reduced price on my 4 calls and still have all take advantage of a short term pop.
Finally, traders can make bets that might happen, like buying the 4.5 calls or the 3.5 puts. Until now if one didn't want to play the ATM strike, they really didn't have many options, in what options to trade. If I want to sell puts, the 3.5s at .09 might not be a bad sale. Certainly better than the .03 or .04 cents I would get for the 3 puts.
All of these are good things, great things really. However, there are some problems; in my mind the negatives are that it will reduce liquidity on the main strikes. This could cause make fills tougher in the back months. I think having strikes that trade everywhere could create more stock volatility. It will also increase the amount of quoting necessary for those that trade this issue. Traders with slower computers may see slower quotes during the busy hours, not a good thing. It could also lead to a large increase in flash trades, dark pool trading, and program trading, none of these add value, but they do take value away. It will certainly lead to market making pickoffs; I’ll be interested to see how fast a price feed needs to be in order to NOT Get burned by an algorithm in this product. If it is too difficult to trade this product, watch the actual BID and Offers disappear. This is a real danger, but if we assume this won’t happen then one can make a case the good outweigh the bad for .50 options in C.
My only question would be why C?
The stock has not move l10% from the 4 dollar strike in the since the flash crash. I can think of many other products where these might make much more sense. A stock like BRCD, ELN, SQNM, or VVUS might make more sense. This is because while inexpensive these stocks are actually volatility. Unlike C. In the end, there was good volume in the back months at the half strikes. If that is what really matters, than this was a fine choice. If this ends up being a success, which it probably will, then expect to see these pop up on a large number of low priced options. Who knows this could go the way of the penny pilot and sweep all products.
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