Mini Option Contracts

Posted on April 18th, 2013

Some of you might have heard about a new option product known as “Mini Option Contracts”. Instead of having the standard multiplier of 100, they have a multiplier of 10. Here is the example of the how the difference will work:
You can see the bid/offer doesn’t change but the multiplier does. That means that the notional of “Value of Deliverable” reduced by 10x.

The mini option contracts are in, what I call, a trial period and are being offered on a limited number of tickers (5) that the SEC describes as “high priced securities where the standard contracts exhibits significant liquidity”.  Those 5 tickers are:  SPDR S&P 500 (SPY), Apple, Inc. (AAPL), SPDR Gold Trust (GLD), Google Inc. (GOOG), and Inc. (AMZN).
You can read the SEC Release from June 2012 here.

So why use mini option contracts? For Buy and Hedge followers, they provide 2 benefits.  The first is that it allows us to use our “Inner Guru” on these popular securities without having to push our implied leverage too high. Second, it allows for more a more efficient and flexible use when it comes to setting and paying for hedges. I’ll explain both of these.
Implied Leverage: When we say it helps our Inner Guru from pushing our implied leverage too high, we mean that it allows a position to be created on these higher priced securities without creating too much market control aka notional value.

Today if you wanted to make a play on GOOG before its earnings tonight you would have hold the stock or use a synthetic position like a spread to do so. Either way, if you were to be hedged with standard options you would need to control 100 shares. With GOOG trading at $775 that means you would control at a minimum $77,500 worth of market value. This could be impossible if wanted to keep idiosyncratic bets between 10 to 20% of your overall portfolio. How many of you have played AAPL and had to ignore those limits just to get a position established? I bet a lot of you did.

Now with the mini option contracts, you can create 1/10th of that position and not feel like too many of your chickens are in one basket. For example, if you wanted to take a bullish bet on GOOG earnings tonight you may consider an ITM call at 10% below the current price. That would mean the MAY 13 700 Call. Right now, both the standard and mini call can be bought for about $78 per share.  For the standard contract, it would require $7,800, but for the mini, it would require only $780.  As a reminder what it costs you is the max loss you can experience, so this also makes it a lot more digestible if you didn’t feel like rolling the dice with nearly $8,000.
Hedging Efficiency: Our second point about the mini options is that they will allow hedgers to be more efficient with their protection. The SPY is a core holding for many of our clients and we recommend it comprise somewhere between 30 to 50% of a long-term portfolio.  With the underlying trading at $155 it means we’re buying even lots of 100 shares for $15,500 at a time. We do this so we can create protection for those shares by buying a corresponding put at some strike below it that defines the risk level. And while that is fine for larger accounts, smaller portfolios don’t have many ways to adjust their risk tolerance.

Now with mini options, an account can move away from lots of 100 and can choose how many shares to hedge. For example: In the past if you wanted to use a collar, (which is long stock, long a protective put, and short a call) in order to keep hedging costs as low as possible you would need to buy even lots so you could sell calls against the put. Any non-lot shares would be unhedged and not generate income from call selling.

However now, if an even lot doesn’t work out right for your portfolio, you can enter into smaller lots of 10 vs. 100 shares. So if you had a $50k portfolio you wanted to hedge and allocate 50% to a SPY position ($25k) you can buy 160 SPY shares (160 X $155 = $24,800), buy 16 mini puts and sell 16 mini calls. In the past you would have to choose between 100 or 200 shares and be under or over allocated. Now you can be as efficient as an account with $500k.

Laddering protection also becomes much easier. Laddering puts is a tactic we use to spread out protection by buying 1/3rd of our puts 6, 9 & 12 months out. This allows us to regularly re-hedge at current  market levels or take advantage when hedges go in the money sooner. In the past this was only efficient for portfolios that had 600 or more shares, setting 2 puts for each of those time frames. Now with minis, we can use them for much smaller positions.

These are just two examples of how the make hedging easier for the individual investor, but there are many more like how to generate more income by selling puts without adding too much risk or only hedging a percent of a portfolio by not buying protection on 100% of shares.

It would be great if these options saw a good amount of success and the test was expanded to other popular symbols like MDY, NFLX or PCLN.

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