Exchanges Plan Mini Contracts Amid Record Share Prices
Exchanges seeking to feed demand for options after trading reached a ninth straight annual record are asking regulators to approve smaller contracts, concerned the highest stock prices on record make some of them too expensive.
Apple Inc. (AAPL)’s 41 percent gain this year to $569.18 means it costs $2,455 to buy a call expiring in June with a strike price of $565, according to data compiled by Bloomberg. Google Inc. (GOOG)’s $609.15 share price requires a $1,840 investment for one June contract giving the right to buy 100 shares at $610 each.
The Standard & Poor’s 500 Index (SPX) has rallied 100 percent since March 2009, driving 46 stocks in the measure to at least $100 a share. Equity option volume has slipped 7.7 percent in 2012 from last year and three venues plan to join the existing nine. The smaller contracts, giving the right to buy or sell 10 shares instead of the current 100, are aimed at individuals looking to hedge after the average price of a stock in the S&P 500 climbed to a record $58.52.
“For a retail account to buy options on Apple, it becomes a substantial investment,” Andy Nybo, principal and head of derivatives at New York-based Tabb Group LLC, said in a phone interview. “It’s all about attracting order flow and one way to do that is by providing new products that answer investor needs.”
The Securities and Exchange Commission is arranging a meeting with NYSE Arca Options and the International Securities Exchange to discuss terms they’ve proposed on so-called mini- options. TD Ameritrade Holding Corp. (AMTD) and the Securities Industry and Financial Markets Association urged the venues to avoid creating confusion by offering different specifications for similar products.
“The SEC has reached out to us to see if we would be willing to work with them and any other interested exchange to forge a common proposal,” Molly McGregor, a spokeswoman for New York-based ISE, which is owned by Deutsche Boerse AG of Frankfurt, said in an e-mail. She said ISE would support the effort.
NYSE Arca Options will participate in the meeting, said Katrina Clay, a spokeswoman at New York-based NYSE Euronext. John Nester, an SEC spokesman, declined to comment.
Higher prices for stocks and exchange-traded funds such as the SPDR Gold Trust (GLD), which trades for $156, limit the ability of investors who own fewer than 100 shares to use hedging strategies, Christopher Nagy, managing director for order routing and market data strategy at TD Ameritrade, said in an April 30 letter to the SEC. He suggested the SEC reject the proposals from both exchanges and said the venues should work together to agree on a common methodology.
Trades in so-called odd lots, or transactions of fewer than 100 shares, have increased at TD Ameritrade and elsewhere as prices have risen.
About 77 percent of executions in Apple by TD Ameritrade’s customers occurred in odd lots last month, the company told the SEC. Clients conducted 84 percent of their trades of Google shares through odd lots, 69 percent for Amazon.com Inc. (AMZN) and 84 percent for Priceline.com Inc. (PCLN), the broker said. Amazon closed at $222.98 today and Priceline, the highest-priced stock in the S&P 500, ended at $718.95.
NYSE Arca Options and ISE asked the SEC for permission to trade equity derivatives based on 10 shares for at least five stocks. Terms such as strike prices and the multiplier used to determine the cost of the options’ price differ in the two proposals and wouldn’t permit the products to be interchangeable. The exchanges also proposed different requirements for when smaller-size options could be created on stocks and ETFs.
“The direction we’ve been getting from the industry is that it’s preferable for us to come to terms with our competitor and have a single product,” Amy Farnstrom, co-chief executive officer of NYSE Arca Options, said in an interview at an options-industry conference in New Orleans on May 4. “I can’t imagine we won’t follow the feedback we’re getting. Many people see strengths in both proposals and it would be a more consistent approach to launch one product.”
The SEC must supervise discussions about the specifications for mini-options between the exchanges to avoid antitrust issues that may arise, said Farnstrom, who is also head of U.S. options business technology for NYSE Arca and NYSE Amex Options, an equity derivatives venue co-owned by NYSE Euronext (NYX) and a group of seven brokers.
Sifma said it supported TD Ameritrade’s suggestion that the SEC work with NYSE Arca Options and ISE to create standardized mini-options, according to Jim Boyle, an executive in the options business at UBS AG who is on the trade group’s options committee.
NYSE Arca, the ISE and other exchanges “need to come together and reach a consensus, or a consensus should be pushed forth by the regulators so the contracts are consistent and fully fungible,” Randy Frederick, managing director for active trading and derivatives at Charles Schwab Corp., which has $1.83 trillion in client assets, said in a phone interview yesterday from Austin, Texas. Contracts that are fungible have the same terms and are interchangeable with those bought and sold on another exchange.
The NYSE Euronext exchange, which proposed its version of a mini-option in March, recommended strike prices that are a tenth the size of the current contracts while ISE suggested using the same strike prices as the standard-size contract and cutting the multiplier instead. It said in its April request that the multiplier should be 10 instead of the usual 100 to reflect the smaller size.
Mini-options would also be available on different stocks and ETFs under the two exchanges’ proposals. NYSE Arca said it would list five contracts based on shares that are at least $100 and whose standard options have an average daily volume of at least 45,000 contracts over the last three months. ISE provided no limit to the number of options it would offer and said they should be based on securities with prices of at least $150 and a three-month average daily volume of 10,000 contracts.
Ralph Edwards, director of derivatives strategy at Investment Technology Group Inc. in New York, said he’s cautious about the prospects for mini-options on high-priced securities.
“There’s a real-life balance between institutional, professional and retail investors in this marketplace and anytime you try to create a product that just really satisfies one niche, I’m skeptical it’s going to have legs,” he said yesterday.
The Chicago Board Options Exchange Volatility Index, or VIX (VIX), which measures the cost of S&P 500 equity derivatives, rose 5.4 percent to 20.08 today. Its European counterpart, the VStoxx Index, a measure of Euro Stoxx 50 Index option prices, fell 0.4 percent to 31.21.
The CBOE, which said it supports smaller-size contracts for high-priced securities, told the SEC it should address issues related to when a venue or broker can buy or sell at a price worse than what’s available elsewhere when options of two sizes are trading at the same time. The issue has come up in earlier discussions about contracts of different sizes, the exchange owned by CBOE Holdings Inc. (CBOE) told the SEC in a letter on April 30.
“It would be great for traders looking to sell puts in stock they are willing to own,” Joe Kunkle, founder of OptionsHawk.com, a Boston-based provider of options-market analytics, said in an e-mail yesterday. “It would likely be popular for small retail investors and could encourage them to use options to tailor the risks in their portfolios.”
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