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Mini Options for Equities and Exchange-Traded Funds: A Failing Product

Standard covered call writing contracts consists of 100 shares deliverable. When we sell one standard covered call contract we are agreeing to sell (deliver) 100 shares. Since many retail investors lack the capital to first buy 100 shares of expensive underlying securities or even the options themselves, new products known as mini options were created.

 

Definition

Mini options are an options class that carries a deliverable of 10 shares of the underlying with similar strike prices and expirations as the standard contracts. Initially, there were 5 equity/ETF underlyings:

  • AAPL
  • AMZN
  • GLD
  • GOOG
  • SPY

GOOG has since been removed from this list

 

How are minis different from standard options?

  • Trading symbols will differ as the suffix of “7” is added (AAPL7, for example)
  • Minis deliver 10 shares, not 100
  • Total value per Mini is 1/10 of the standard contract with the same strike and expiration

 

Commissions will doom Minis

I wrote an article on these products before they were initiated and expressed my concern for trading commissions per share. My hope was that brokerages would reduce standard trading commissions so they wouldn’t have a major negative impact in our option-selling profit…they did not.

 

AAPL options chain as of 10/25/2016 for the 11/18/2016 expiration

 

covered call writing with Mini options

AAPL Options Chain on 10/25/2016

We see that with AAPL trading at $117.47, the $118.00 near-the-money strike returned $2.75 per share for a 4-week obligation. Let’s assume a total $20.00 commission to buy the shares and sell one options contract.

 

Calculations for the standard options contract

($275.00 – $20.00)/$11,747.00 = 2.2%

 

Calculations for the Mini options contract

($27.50 – $20.00)/$1174.70 = 0.64%

The impact of the commissions reduced the initial profit by 71%

 

Discussion

The creation of equity mini options was doomed to failure because of the impact that trading commissions have on the bottom line. In essence, we are paying ten times the commissions per share with minis. This is an unworkable scenario. As a result, GOOG has stopped trading Minis and option liquidity is extremely low and in some cases non-existent for the other underlyings. I see no way for these products to be sustained and expect them to disappear in the near future.

 

Upcoming live events

1- April 13, 2017 (changed from April 6th)

8:30 AM

Alan will be interviewed on Benzinga Pre-market Radio Network regarding the best strategies to use in the current market environment.

Information and link to follow

2- April 12, 2017

3:30 – 4:30

Income Generation Webinar for the Options Industry Council

Information and link to register

 

Market tone   

Global stocks rose this week. West Texas Intermediate crude also advanced to $50 from $47.80 last Friday. Volatility, as measured by the Chicago Board Options Exchange Volatility Index (VIX), held steady at 12.37. This week’s reports and international news of importance:

  • The United Kingdom formally began the process of withdrawing its European Union membership this week by triggering Article 50 of the Lisbon Treaty. The UK and EU now enter into a two-year negotiation
  • After suffering a severe defeat in his first major legislative initiative, President Trump is likely to turn his focus to taxes in the hope of unifying the Republican congressional caucus
  • That may be more difficult than anticipated as the approximately $1 trillion in savings over 10 years that was expected from the repeal of Obamacare and its replacement with the American Health Care Act (AHCA) is now off the table
  • Trump must now decide whether to risk further political capital by advocating an ambitious comprehensive tax reform plan or to play it safe and advocate a smaller program of tax cuts. Should negotiations drag on, markets may not receive the fiscal stimulus that they’ve been expecting this year. Some fear stimulus could be smaller than expected and later in arriving, perhaps not until 2018
  • 4th quarter US gross domestic product was revised up to a 2.1% annual rate this week from an earlier 1.9% stat
  • Corporate profits showed healthy growth of 9.3%, though the persistent US trade deficit restrained economic growth. Sluggish growth is expected to persist into the first quarter of 2017
  • South African president Jacob Zuma fired his market-friendly finance minister Pravin Gordhan this week in a move that risks prompting a downgrade of the country’s sovereign debt ratings
  • A leaked draft of a US Department of Commerce memo this week showed that the Trump administration will seek quite modest changes to the North American Free Trade Agreement, countering more extreme proposals made on the campaign trail by President Trump prior to his election
  • Unemployment in Germany, Europe’s largest labor market, fell to a post-reunification low of 5.8% in March, as joblessness fell by 30,000. That was more than the 10,000 that economists had predicted
  • Former South Korean president Park Geun-hye has been arrested and jailed over corruption allegations. A snap election to replace Park will take place on May 9th.

   

THE WEEK AHEAD

MONDAY, April 3rd 

  • Markit manufacturing PMI March
  • ISM manufacturing March

TUESDAY, April 4th

  • Trade deficit Feb
  • Factory orders Feb

WEDNESDAY, April 5th

  • ADP employment March
  • Markit services PMI March
  • ISM non-manfacturing March

THURSDAY, April 6th

  • Weekly jobless claims 4/1

FRIDAY, April 7th

  • Nonfarm payrolls March
  • Unemployment rate March
  • 10 am Wholesale inventories Feb.

For the week, the S&P 500 moved down by 0.80% for a year-to-date return of 5.53%. 

Summary 

IBD: Uptrend under pressure

GMI: 4/6- Buy signal since market close of November 10, 2016

BCI: I am currently moving slightly more defensively until political issues calm, resulting in favoring in-the-money strikes 2-to-1..

WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US

The 6-month charts point to a neutral to a cautiously bullish outlook. In the past six months, the S&P 500 was up 10% while the VIX (12.37) declined by 6%.

_____________________________________________________

Wishing you the best in investing,

Alan (alan@thebluecollarinvestor.com) and the BCI team

 

 

 

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

36 Responses to “Mini Options for Equities and Exchange-Traded Funds: A Failing Product”

  1. Bill April 1, 2017 10:22 am #

    Alan

    I have a question and hopefully get the answers from you or you can direct me to the article related to this question. I know we never sell and option during earning report but should we do the following:

    * Keep the stock during earning reports ? or Ex dividend ? I like to keep stocks (to get dividend and can sell calls months after months, so should I get out (flat on stocks) and buy it back again after earning report (to continue selling calls after earning report)

    * If not then we move around using different stocks by selecting those in weekly report, but this might not being able to get dividend desired ?

    Thank you for helping and I enjoy to be a BCI member.

    Thank you

    Bill

    • Alan Ellman April 1, 2017 10:29 am #

      Bill,

      Stocks can be held through earnings reports in rare circumstances. Do not write the call until the report passes. Use this approach in situations where we have historical statistics of positive reports (“beats”). Years ago, I used this approach for CSCO and AAPL. Most of the time, we do not have these securities in our covered call portfolios until the reports pass.

      If we want to avoid early exercise due to ex-dates, see this article I previously published:

      http://www.thebluecollarinvestor.com/how-to-avoid-early-exercise-when-dividends-are-about-to-be-distributed/

      There is also a lot more detailed information in the “Portfolio Overwriting” chapters of my books and DVD programs.

      Alan

  2. Jim April 1, 2017 10:35 am #

    Good Day Alan;

    I hope your planned move may all be behind you now!

    To date, I’ve mainly written CC’s on positions I previously held.

    I admit, I feel like panicking when my Calls drop to an ITM condition.

    You’ve referenced that the ITM Call (may, or is?) the more conservative play?

    I can’t locate (when I need it) a tutorial video explaining the ITM and its conservative nature.

    I’d appreciate a reference to this condition as I prefer to sleep at night and didn’t begin writing options to keep me awake! :)

    Thank you

    Jim

    • Alan Ellman April 1, 2017 10:39 am #

      Jim,

      Learning how and when to use ITM strikes is a mainstay of the BCI methodology. There is a huge amount of information with detailed examples regarding strike price selection in all my books and DVD programs. Here is a link to an article I published on this topic 5 years ago:

      http://www.thebluecollarinvestor.com/in-the-money-strikes-and-covered-call-writing/

      Alan

    • Geoff April 3, 2017 9:45 am #

      ITM is more conservative because it’s like having a “put” on the first dollar of losses, e.g. if you buy a stock for $53 and sell an ITM $50 call and the stock declines, you will not participate in any losses until the stock declines beyond $50 / share. In short, no pun intended, you’re “reinsuring” the position. The call buyer will be lowering his breakeven point (lowering his extrinsic value cost) by assuming more risk and a higher capital investment.

  3. Roni April 1, 2017 12:02 pm #

    Alan,

    Schwab has recently reduced the commissions from aprox. $10.00 to aprox. $5.00, which is very helpful, but it remains 10 times higher for the MINIs, and therefore, it continues to be, as you say, an unworkable scenario.

    It becomes a little more interesting when you do a buy/write, but if you need to trade the options more than once during the contract cycle, the multiplied comissions will continue to erode the bottom line as you explained.

    I have never traded MINIs, and also they usually have low near-the-money strike ROO premiums (less than 2%), which turns me off anyway.

    Have a nice weekend – Roni

    • Alan Ellman April 2, 2017 11:45 am #

      Roni,

      Thanks for sharing.

      The competition among brokers for our business is heating up more than ever. I believe that commissions will continue to decline and get closer and closer to zero. There could be a day when brokers profit is from the bid-ask spreads only…all good for retail investors.

      Alan

  4. Barry B April 1, 2017 9:08 pm #

    Premium Members,

    This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member site and is available for download in the “Reports” section. Look for the report dated 03/31/17.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:

    http://www.youtube.com/user/BlueCollarInvestor

    Important note:

    The report for next week (04/07/17) will be uploaded late on Monday, 04/10/17.

    Best,

    Barry and The Blue Collar Investor Team

  5. Justin P. April 2, 2017 11:18 am #

    I’m only monitoring them, but some interesting weeklies on offer with CRUS 60.5 showing a ‘negotiated’ ROO of 1.3% and NTES 282.5 and 285 offering very similar returns.

  6. Phillip April 2, 2017 11:40 am #

    I’ve been watching your covered call youtube videos and I appreciate them. May I have the name of a stock that has currently passed your fundemental screening process so that I can practice studying the technical aspects and option chain. I am not current trading but past interest has recently returned.

    Thank you even for just considering.

    Phillip

    • Alan Ellman April 2, 2017 11:55 am #

      Phillip,

      Welcome to the BCI community.

      A stock currently on our list (not necessarily a recommendation) that shows bullish technicals ( as shown in the screenshot below) is MKSI. Keep in mind that we are 2 weeks into the April contracts.

      You are doing the absolute right thing by taking your time to learn and develop the 3 required skills (stock selection, option selection and position management).

      CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG

      Alan

  7. Jay April 2, 2017 6:18 pm #

    Since we have had great discussion about ITM covered calls and Alan has moved to a higher % of them I thought I might share an example I am looking at on XLF. My hope is it sparks thoughts about the many uses of covered calls with any ticker we might own even if we did not buy it pointedly as a “covered call” position.

    As we know, the banks took off after the election. The sector assumed a leadership role and our Premium List was awash in financials!

    I bought XLF @21.50 shortly thereafter. The call premiums at the time did not warrant loss of upside potential in my bullish view. So I did not cover it. I bought it purely as a capital gains candidate in my IRA. XLF went on to make a near term peak at 25, backed off to 23 and is now near 24. Few love the sector as much anymore – welcome to the world, XLF :).

    But I do not want to sell it since the FOMC meets first week of May and an interest rate hike will help XLF while the lack of could help all stocks. My answer? Cover it ITM for April using the weeklies to be uncovered during the FOMC .

    I’ll be watching the ITM $23 Apr 28 dated strike tomorrow. Sunday pricing is squishy but it’s at 1.00. So that plus my $1.50 gain gives me $2.50 on a $23 strike resulting in 11% down side to work with for the month.

    Point is stocks/ETF’s you may not have written against while uber-bullish change. And writing ITM against profits in a rocky time can add loss protection instead of just selling a winner on a possible short term blip. So it is a handy tool to have.

    Hope everyone has a great week. – Jay

  8. Murray April 3, 2017 10:58 am #

    Is there a selling put strategy involving ex-dividend dates? I am doing excellent selling puts and out of 18 trades I have not lost a penny but make an average of 2 to 3% in 3 weeks. I had 60K in capital tied up in all the put options.

    Thanks
    Murray

    Would love to see you if you ever get to Vegas

    • Alan Ellman April 3, 2017 2:04 pm #

      Murray,

      Glad to learn of your recent success. Keep up the good work.

      It is instructive to factor in that an ex-date results in share value declining by the dividend amount. This means that put value will be higher than call value as puts benefit from share decline and calls do not.

      This slightly increases the possibility of a put strike ending in-the-money at expiration and so if exercise is not wanted we may want to go deeper out-of-the-money when an ex-date occurs prior to contract expiration.

      Alan

  9. Alan Ellman April 3, 2017 11:41 am #

    Event update:

    1- Benzinga radio pre-market interview moved to April 13th at 8:35 AM ET

    2- Just added: Palm Beach Trader’s Group seminar:

    September 12th, 2017 7 PM – 9 PM

    Palm Beach Gardens Florida

  10. Jerry April 3, 2017 12:22 pm #

    What is the optimum delta for a call in a covered call position?

    Thanks,
    Jerry

    • Alan Ellman April 3, 2017 2:10 pm #

      Jerry,

      The optimum Delta will depend on our assessment of the best strike to use based on overall market assessment, chart technicals and personal risk tolerance. One size does not fit all.

      Most of the time, our Delta will be in the 40 – 60 range because near-the-money strikes will generate the type of premiums that meet our goals. If we decided to take a more conservative or defensive posture, we go with higher Deltas and if we are more bullish we choose lower Deltas. Generally, the guideline is in the 40 – 60 range.

      Alan

  11. MarioG April 4, 2017 6:59 am #

    I have been watching AVGO and AMAT for the 20% BTC rule threshold.

    AVGO finally crossed 20% Rule threshold today in 2 positions. Now let’s see if I can hit a double! I have 3 full weeks for that to happen.

    What I found out is that since I initially Sold OTM calls, the ROO% at the 20% rule is decent. The BTC only lost 0.25% in Gain (-0.6% to -0.85 %) and the loss is only $189 based on a cost basis of $222.72 in the position.

    I did as Alan suggested to set up GTC orders after I initially set up Alerts at Fidelity and OptionsHouse slightly above the 20% rule. I did not want to set up a GTC order initially on the opening trade since it affects my Cash available to trade value in my brokerage account since they hold the money in escrow.

    Near the alert, I then set up GTC BTC orders at the 20% level and just waited it out.. I have done the same with AMAT with a GTC order since it is also close to the threshold..

    Here is one of the AVGO positions:
    A. 3/17/17 Week 1 Initial Opening:
    Buy AVGO 100 Sh at 222.72 STO 230 Call expire 4/21 at 2.58 R00%= 1.16% Upside Potential 3.27%.
    ROO Cost Basis: 222.72 (OTM Call), Breakeven point: 220.14

    B. 4/3/17 Week 3/5 20% Rule crossed:
    AVGO at 218.8 Gain = (-1.34), ROO% = -1.34/222.72 = -0.6%
    20% Rule = 20% 2.58 =0.52
    BTC 230 Call Expire 4/21 at 0.55 ((includes commission)
    BTC effect on ROO% = 0.55 / 222.72 = 0.25%

    New Breakeven point = 220.14 + .55 = 220.69
    New Gain = (220.69 – 218.8) = -1.89 ROO% = -0.85%, which agrees with the 0.25% change.

    .******
    Here is my overall status.

    %invested 94%, ITM / OTM ratio 0.4 (1/2). 17 positions with 9 securities in 4 accounts, 4 industries. ROO% for this cycle is 1.2% Annualized 12.3% despite the market being down recently. 10 are new positions and 7 are rollouts or carried over from last cycle.

    Note: I zero out my gain (as well as any losses from a stock position I may be holding) at the beginning of a cycle so I can get an accurate reading for the current contract cycle. Using a modified version of Alan’s Prolit/Loss 2015 Spreadsheet.)

    • Geoff April 4, 2017 8:13 am #

      I’m not making any recommendations, but you may want to check the price and volume action on AVGO. It looks like there is higher volume on the down days than on the up days and the recent run-up from the lows was on low volume.
      AMAT seems to be more trending by comparison but both are chip makers. So you may want to evaluate your concentration in sectors?

      • MarioG April 4, 2017 10:31 am #

        Thank you, Geoff for your comments on volume. Will look int to it. There are a lot of inter-dependencies with this business so do the best I can..

        Last month I had a lot financials and did ok but liquidated them as they soured and still got a 1.5% end of cycle performance.

        I will keep a watch on AVGO.with respect to my BEP. I also have NVDA (another CHIPs) but it has a good history of support at where it is at now and a good income source and I intentionally bought an ITM option to give me good downside protection.

        I was holding TTMI (Computer) as stock as well waiting for a double and lo aand behold JP Morgan upgraded this morning to Outperform and it shot up more 6.1% (16.71) ($970 Todays gain) at the moment. I have a BEP of 17.025 so let’s see what I decide. My original purchase price was at 17.6 on 2/14 with a strike at 17.5 ITM. One is tempted to liquidate and just come out near even. and put money someplace else.
        .

        .

        • Geoff April 4, 2017 2:02 pm #

          No problem, Mario. I’m a bit more conservative. I do a bit of a top-down analysis of the market. So, right now I’m about neutral on the domestic markets (not much bias up or down). The past couple of months are in the context of a continuing bull market but I’m not asking for through the moon type returns of my securities here. I did well with the financials but saw them starting to take a turn down and went ahead and exited. I can see them possibly making another run after some consolidation but I can also see them continuing to flounder about with the political environment shedding a bit of a questionable light on what may be accomplished (or not accomplished) in the regulatory arena.

          I moved into utilities a bit (XLU) and it’s done well for me through now. That trade will end 04/21 at the latest, and I don’t know that I’m willing to roll it forward. We’re in a mixed environment with the “risk-on”/”risk-off” behavior. There’s a lot of rotation back and forth as the market is trying to decide whether to push forward or roll toward a correction. All-in-all, I’m not really pushing for high or low beta stocks, I’m just going with what is working and playing my strikes on the more conservative (mostly ITM) side.

          Happy trading!

  12. Alan Ellman April 4, 2017 7:31 am #

    Link now available to register for my free presentation on income generation for the Options Industry Council on April 12th 3:30 – 4:30:

    https://www.optionseducation.org/seminars_events/events/event.E-00001777.html

  13. Serre April 4, 2017 6:37 pm #

    Alan,

    Just sold my 1st cash secured Put today.

    To determine potential discount if exercised, how do I determine the exact price the stock was trading at when I executed the trade?

    Thanks,

    Serre

    • Geoff April 4, 2017 7:26 pm #

      The discount doesn’t have to do with where it trades but instead the strike price less the premium received. Where it trades only had to do with your margin pic safety against assignment. I hope this helps! :)

    • MarioG April 5, 2017 8:13 am #

      Serre,
      As Geoff replied, the purchase discount price is fixed by the Strike – Premium.

      To get your Purchase Discount percentage, using a price chart, just take the closing price for that day and use that as a convenient reference of take the average of that day and the previous day to get a midpoint of the Purchased Underlying Price (UPur)

      The Purchase Discount % is (1- ( (Strike-Prm)/UPur) ) x100.

      I got into the habit of listing the underlying price at trade time when recording the filled order. I try to always do that as well when I do a Buy to Close for a Call or Put.

      Good luck with your trading.

      Mario

    • Alan Ellman April 6, 2017 7:46 am #

      Serre,

      If a stock is trading at $50 and we sell the $47 cash-secured put for $2, we have a potential discount of 10% if exercised. If exercised, our cost basis is $47 – $2 or $45, a $5 discount from when the put trade was initiated. This highlights how selling out-of-the-money puts can be used instead of limit orders when looking to buy stock at a lower price than current market value. Keep in mind that this 10% represents the discount from when the put trade was initiated, not when the actual exercise takes place.

      Alan

  14. Justin P. April 5, 2017 4:53 am #

    Quick question for IB users: whereabouts do you enter a stop limit buyback order? (So as to follow Alan’s 10%/20% rule).

  15. Alan Ellman April 5, 2017 6:58 pm #

    Premium Members:

    This week’s 8-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site and is available in the “ETF Reports” section. Look for the report dated 4-5-2017.

    ***This week’s stock report will be published a bit later than usual (between late Sunday and Monday) as we have a few team members taking a well-deserved vacation. This was planned so the later-than-usual report is not at the beginning of an options contract.

    ***Next week’s ETF report will be published on Tuesday, a day earlier than usual, so as not to conflict with the webinar I will be hosting for the Options Industry Council.

    Next week’s live events:

    Wednesday April 12th:

    1- April 12, 2017
    3:30 – 4:30
    Income Generation Webinar for the Options Industry Council
    Information and link to register

    2- April 13, 2017
    8:30 AM
    Alan will be interviewed on Benzinga Pre-market Radio Network regarding the best strategies to use in the current market environment.
    Information and link to follow
    For your convenience, here is the link to login to the premium site:

    http://www.thebluecollarinvestor.com/member/login.php

    NOT A PREMIUM MEMBER? Check out this link:

    http://www.thebluecollarinvestor.com/membership.shtml

    Alan and the BCI team

  16. George April 6, 2017 2:29 am #

    Hi Alan,

    I’m still having a great time practicing. However, I am a little concerned about buying back options. I don’t yet have a feel for the right time to buy back an ITM call. Intuitively, I know that for an OTM call, the time to buy back is before the strike price equals/exceeds the stock price. I just don’t know the other way around. Is it when the intrinsic value of the ITM goes to or approaches zero?

  17. Alan Ellman April 6, 2017 7:35 am #

    George,

    If an ITM strike trades near “parity” (almost all intrinsic value with little or no time value component), there is an opportunity to close at no cost (see information on the mid-contract unwind exit strategy in my books and DVDs) and generate a second income stream in the same month with the same cash in a new position.

    The other time it makes sense to buy back an ITM strike is at expiration and we evaluated that rolling the option is in our best interest.

    Alan

  18. Catherine April 6, 2017 5:09 pm #

    Alan

    I have two questions:

    1) ITM options provides downside risk protection to the option sellers. I don’t quite understand why would any investors ever wanting to buy a ITM option. What benefit do they get that make them willing to pay for that extra intrinsic value upfront?
    2) If stock prices goes beyond the strike price I sold, and I want to keep my stocks for further upside potentials, how can I do that? Do you have any videos or materials that covers that?

    Thank you again! You have inspired me to spend more time to understand this great strategy.

    Catherine

    • Jay April 6, 2017 7:19 pm #

      Catherine,

      Glad you are here and spending time understanding these great strategies!

      I buy speculative long calls and puts all the time in the trading portion of my IRA. I ONLY buy ITM options and ITM spreads.

      A couple reasons: the intrinsic value I buy helps dampen time decay. And the delta, or the amount the option will go up if I am correct on direction, is significantly higher.

      Many beginning options speculators – and, to be clear, there is little that is speculative about cash secured put selling or covered call writing – buy OTM options because they seem inexpensive. They don’t realize all they are are buying is time value which will decay every day and faster still if the position moves against them.

      Hope that helps! – Jay

    • Geoff April 6, 2017 11:56 pm #

      I’ll extend on what Jay said here:

      1) There is a risk/reward balance. There’s a pricing “curve” to an option as it’s entirely an exchange of risk. An ITM option is sold by you because you’re “buying” protection for the first dollar(s) of loss. In exchange for taking that risk, the call buyer has a higher delta option, e.g. it will appreciate at a higher rate dollar for dollar of the underlying.

      Quick example: An 80-delta (0.80) option (ITM) versus a 20-delta (0.20) option (OTM). If the stock appreciates $1, the 80-delta call will appreciate $0.80 (all else held equal), the 20-delta option will only appreciate $0.20 on the same move. So, the 20-delta is “cheaper” to buy than the 80-delta.

      On the other side of the trade, you will have less of a payoff selling the 80-delta option versus the 20-delta option. The 80-delta will be mostly intrinsic value. The 20-delta option will be entirely extrinsic value and at a greater rate than the 80-delta option.

      2) To retain a stock, you will need to buy-to-close the option before it expires ITM. Note: just because it breaches the strike price does not mean that it’s going to end ITM. I sell ITM calls all the time and I know they’re not going to be exercised early because of the extrinsic value and also because there aren’t any ex-divs to worry about.

      I’m going to provide a screenshot below to show that the more ITM a call is, the less expensive it is to the call buyer (less extrinsic/time-wasting value):

      This is XLU, I randomly chose the May 19 standard expiry–these are only the calls, I excluded the puts:

      If you look at the breakeven price on each strike you’ll see some striking (no pun intended) differences,

      The stock closed at $51.62 / share, the ITM 45 strike calls are selling for $6.85 so the breakeven is $51.85 which only represents a time value of $0.23 / share. Now, we can look at the OTM 55 strike calls which are selling for $0.08 / share with a breakeven price of $55.08.

      So in comparison, you can see that you’re spending $0.23 to participate in a lot more potential upside or you can spend $0.08 and that stock needs to REALLY move to get ITM. The call would appreciate in the meantime and the percentages gained on the call which would likely be resold would be phenomenal. However, it’s expensive and the risk of total loss is also very high.

      If pricing is efficient, the expected payoff is going to be the same across all reasonably near the money strike prices. Pricing should be pretty efficient in liquid options.

      In any transaction, you just have to ask yourself how much risk you want and how much risk you want to mitigate. Many people have purchased a call option in their lives without realizing it–a mortgage rate lock. A mortgage rate lock protects the prospective house buyer from a sudden upward shock in interest rates that might put their dream home out of reach in terms of monthly payments. What they may do is pay a fee for a “rate lock” which is the transfer of risk of interest rate increase to the seller. If rates stay the same or go down the seller keeps the premium paid. If rates shoot up, they may take a small loss. You can bet the pricing is very favorable to the seller as most people buying a rate lock aren’t going to be the world’s most savvy finance people.

      I hope this helps!

    • Alan Ellman April 7, 2017 8:18 am #

      Catherine,

      Not much to add to Jay and Geoff’s outstanding responses.

      One additional minor thought:

      When we sell an ITM strike, a holder of that strike may have purchased the option when it was OTM or ATM. Let’s say a stock is trading at $48 and an option buyer purchases the $50 OTM call. A week later, the stock is trading at $52 and we come along and sell the $50 (now) ITM call. It’s the same option but the underlying has changed the “moneyness” perspective of that option.

      The key takeaways are the points made by Geoff and Jay and to know that there will always be a market for ITM strikes when we are dealing with liquid stocks and ETFs.

      Alan

      • Catherine April 7, 2017 11:11 am #

        Thanks, Allan! I will take some time to digest. 😊 Plan to order your books.

        Catherine

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