Explore Your Options
| Got a question about options? Tom Gentile is the chief options strategist at Optionetics (www.optionetics.com), an education and publishing firm dedicated to teaching investors how to minimize their risk while maximizing profits using options. To submit a question, post it on the STOCKS & COMMODITIES website Message-Boards. Answers will be posted there, and selected questions will appear in future issues of S&C. |
Tom Gentile of Optionetics |
OPTIONS THAT EXPIRE WORTHLESS
What percentage of calls that are sold on underlying stocks expire worthless? -- Perry Buckman
It is impossible to say what percentage of calls that are sold expire worthless. However, studies have examined what percent of all options expire worthless. While I have heard traders speculate that 70%, 80%, or even 90% of all contracts do so, the actual numbers are probably much lower. According to a presentation by Alex Jacobson, vice president of the International Securities Exchange (ISE), at the Optionetics Oasis 2004 Convention, a comprehensive study that included more than 30 years of data revealed that only 30% of options expire worthless. Roughly 10% of all options contracts are exercised, and the remaining 60% are closed through offsetting transactions. In sum, traders are more likely to close options through offsetting transactions before expiration than to let them expire worthless.
QQQ Vs. NDX
Can you explain the difference between QQQ and $NDX? I have checked several websites, and it seems that $NDX is the Nasdaq 100 index, and QQQ is the Nasdaq 100 index tracking stock or Nasdaq 100 index option. Are they the same? Thanks -- Jerry
The Nasdaq 100 Index ($NDX) and the Nasdaq 100 QQQ (QQQ) are based on the same index, but are two different types of investments. The Nasdaq 100 index, which trades as NDX, is a cash index that includes 100 of the largest nonfinancial stocks that trade on the Nasdaq stock market. Since it is an index, like the Dow Jones Industrial Average ($Indu) or the Standard & Poor's 500 index ($Spx), it can't be bought or sold. Instead, it is used as a benchmark for the performance of Nasdaq stocks.
The Nasdaq 100 QQQ trades as QQQ. Sometimes called the triple Qs, this investment is an exchange-traded fund that includes the same 100 stocks from the Nasdaq 100 Index. The value of the fund is roughly equal to 1/40th of the NDX. So if the Nasdaq 100 is trading near 1,000, each QQQ share will trade for approximately $25. The QQQ can be bought and sold throughout the trading day like shares of stock. So investors can buy the QQQ when they expect Nasdaq stocks to move higher, and sell (or short) the Qs when they expect Nasdaq stocks to fall.
Options trade on both the NDX and QQQ. However, there are subtle differences between the two contracts. First, the QQQ settles like a stock option -- that is, upon exercise or assignment, shares of the QQQ trade hands. The NDX is an index; it can't be bought and sold. Therefore, the options settle for cash. In addition, the QQQ settles American-style, which means that exercise and assignment can take place any time before expiration. However, the NDX settles European-style and exercise or assignment only occurs at expiration.
So, which is better for options traders, the Nasdaq 100 index or the QQQ? Options on the QQQ are by far the better tool for trading Nasdaq stocks. For one thing, the contract sees a great deal more volume and is therefore more liquid. In addition, the strike prices on the QQQ contract are spaced at just one-point increments, which makes it more practical for implementing strategies like straddles and spreads. Basically, there are more strike prices to choose from with the Qs rather than the NDX.
Finally, traders will also want to consider the mini-Nasdaq 100 index ($Mnx). This index equals 1/10th of the Nasdaq 100 index. Like the NDX, it settles for cash and is European-style. However, compared to the Nasdaq 100 options, the MNX sees greater trading activity and offers greater liquidity.
CREDIT SPREADS
I am a relatively new student to the markets. I have been trying to fully understand the concept of credit spreads. But confusion comes in when I think about the exiting process. ... Can you help? -- Elom
Let's first discuss the bull put spread only. Selling a credit spread is a way of opening the trade for a credit -- that is, we want to sell a put and then buy a put with a lower strike price. This trade will generate a credit in the account because the long put (the put that is purchased) has a smaller premium than the short put (the put that is sold).
Let me describe a trade I did involving Cyberonics (CYBX). I saw that the options premiums were very high and wanted to take advantage of the high volatility. I entered a trade using CYBX June put options, selling the higher-strike options and buying the lower-strike options. In fact, I did quite a few of these, which brought in a lot of premium. When the stock moved higher, as it did in mid-June, I did nothing and let all the options expire worthless. Now remember, I sold this trade for a credit, so I keep the net premium.
If I had been wrong and CYBX fell, I might have been assigned stock at the strike price of my short puts. However, if the stock really took a fall, then I would be protected to the downside by the long put options that I had in place. So, the exit strategy with this type of credit spread (if you're right) is to do nothing and let the options expire. If you're wrong, you want to close the position or face assignment on the short option.
Return to November 2004 Contents
Originally published in the November 2004 issue of Technical Analysis
of STOCKS & COMMODITIES magazine.
All rights reserved. © Copyright 2004, Technical Analysis,
Inc.