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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:
| AMAT |
Applied
Materials |
| BRCD |
Brocade
Communications |
| EMC |
EMC
Corporation |
| EP |
El
Paso Corporation |
| JDSU |
JDS
Uniphase |
| JNPR |
Juniper
Networks, Inc. |
| MU |
Micron
Technologies |
| ORCL |
Oracle
Corporation |
| SIRI |
Sirius
Satellite Radio |
| SUNW |
Sun
Microsystems |
| THC |
Tenet
Healthcare |
| TWX |
Time
Warner, Inc. |
| XRX |
Xerox
Corporation |
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):
| Strike
Price |
Strike
Code |
|
3 |
G |
| 4 |
H |
|
5 |
A |
|
6 |
I |
|
7 |
J |
| 8 |
K |
| 9 |
L |
| 10 |
B |
| 11 |
M |
| 12 |
N |
| 13 |
O |
| 14 |
P |
| 15 |
C |
| 16 |
Q |
| 17 |
R |
| 18 |
S |
| 19 |
T |
| 20 |
D |
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.
This
issue's Question and Answer:
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.
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