Standard Stock Option Strike Prices - and the Problem

As you know, the standard stock option strike prices are in increments of $2.50 at and below $25, and in $5.00 increments for strikes above $25. Of course, there are exceptions to this rule, and many stocks have $27.50 strike prices; indeed, $32.50 strike prices are not uncommon and there are many other strikes in $2.50 increments commonly found above the $25 strike level, usually but not always as the result of a stock split.

But after the crash of the market bubble in 2000, many stocks that had traded at high prices fell to under $20; many under $10. Consider a stock trading at $10: the 7.50 call strike is 25% in the money, the 12.50 strike 25% out of the money. Sure, it's only a $2.50 increment, but 25% is a huge chasm: equivalent to strikes of 37.50 and 62.50 if the stock was instead $50.

Look at it this way: a $7.50 stock has to rise over 1/3rd in price to put the 10 Call in the money. On a $7.50 stock you will seldom get a worthwhile premium for writing the 10 Call. Such huge strike-price gulfs on cheap stocks makes the options less desirable and significantly impairs liquidity, or at least so went the theory at the time.

The Solution - Dollar Strikes

Thus the option exchanges asked the SEC to allow them to quote stock options in $1.00 increments for stocks at or under $20 in price, known as dollar strikes or, officially, as "one-point strikes." I use both terms interchangeably in this newsletter and both usages are correct. The Securities and Exchange Commission (SEC) in 2003 allowed the quotation of dollar strikes in a pilot program that continues to this day.

The pilot program allows the exchanges to list stock option strike prices in $1.00 increments, specifically: 3.00, 4.00, 5.00, 6.00, 7.00, 8.00, 9.00, 10.00, 11.00, 12.00, 13.00, 14.00, 15.00, 16.00, 17.00, 18.00 and 19.00. The program allows the exchanges to list dollar strike prices on equity options for up to five individual stocks provided that the strike prices are $20.00 or less, but greater than or equal to $3.00. Each exchange was limited to five stocks in its pilot program but also allowed to list options on stocks included in a dollar strike program by another options exchange.

The program was not allowed to include long-term LEAPS options and could not result in strike prices being $0.50 apart. This means that where one point strikes are used, there will not be 2.50, 7.50, 12.50 or 17.50 strikes. January 2007 options do not include dollar strikes because those options originally were LEAPS options that converted over time into regular options and as noted, LEAPS were not included in the program. The same was true of January 2005 and 2006 options.

Participating Equities

Although the participating equities may change, the current participants in this single strike program as of this newsletter's date are:

There may be others, but these are the only ones of which I am aware. Certain other stocks that wereonce in the pilot program have fallen out, such as Lucent and Liberty Media (due to mergers) or Motorola and Circuit City (due to an increase in stock price).

How have the one-point strikes worked in practice? According to the options exchanges the program has been a resounding success: volume and liquidity in these options is far greater after institution of the one-point strikes. They have continued the pilot programs, and the SEC has requested a report summarizing the data and observed benefits in order to determine if the dollar strikes should be made a permanent part of the landscape. I think they are here to stay - I hope so.

One-Point Strike Price Symbols

As you are aware, all of the letters of the alphabet have already been used for existing strikes in $2.50 and $5.00 increments. Thus the existing OPRA code structure has been expanded to incorporate new, altered symbols for the one-point strikes (except the ones divisible by 5):

Note that the bolded strikes retain the regular symbol - A for 5, B for 10, C for 15 and D for 20. If the stock is close to $20, it will often have 22.5o (X) and 25 (E) strikes, using the normal symbols for those strikes, which you will note are not in the one-point symbol list above.

As noted, these strikes are not used for January options, which originally were LEAPS options and convert to regular options in time. They are therefore not used for the January 2008 and 2009 LEAPS options, either.

If you see these dollar strikes on our Real Time Lists™, you'll now know what they are and how they arose. They are convenient and allow you to pull in far more premium in many cases. For example if the stock is $15.75, the 17.5 Call is pretty far out of the money. But if dollar strikes are available you could write the 16 or 17 strike for better premium, assuming you wanted to be OTM - or the 15, 14 or 13 perhaps if you preferred to write ITM. Without a doubt the dollar strikes provide far more flexibility in your writing.

Option Premium Increments

Question:
I tried to enter a limit order to write a call for $3.45, but my order was rejected due to entering an "incorrect price." How can a limit price be "incorrect"?

Answer:
Stock option premiums are quoted in fixed increments. If the option premium is less than $3.00, the price quotes (bid and asked prices) are in nickels - increments of $0.05. However, once the premium hits or exceeds $3.00, the increment increases to a dime ($0.10). Thus your order was required to be either $3.40 or $3.50, divisible by a dime, and $3.45 was indeed an incorrect price.