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 |
BUYING, SELLING, AND OPEN INTEREST
I came across something the other day while reading The Wall Street Journal. In the "Leaps-Long Term Options" section, I noticed that the put volume of a stock was quite high compared to the call volume, and the strike price was out-of-the-money. Does this suggest that the "experts" are buying puts because they think the stock will go down, or that they are selling the puts and expecting the stock to go up? Is there any way to get this buy/write volume for a particular strike price?
Unusual increases in volume or open interest can sometimes signal that experts or well-informed investors expect the stock to make a significant move in the future. At other times, large volume can represent a protective purchase of puts, the sale of an open position, or maybe even part of a more complex trade involving other stocks or options. So how do you know what is happening?
Remember, all options trades involve a buyer and a seller. In order to determine which one initiated the trade, you can try to see if the trade occurred at the bid price or the ask price. If the trade happened at the bid price, it was probably a sale. If the trade takes place at the ask price, it was probably a buy. As you can see, unless you can watch the market or have access to time and sales data for the options market, it is often difficult to tell if a certain trade was at the bid or the ask, and therefore it is hard to know if the position was a purchase or a sale. Nevertheless, the price of the trade and whether it was at the bid or ask can give you clues regarding whether it was a purchase or a sale.
Another factor to consider is the open interest. Open interest is the number of options contracts that have been opened and not yet closed out. For example, if the options contract has zero open interest and volume is 1,000 contracts on the day, this is probably an opening transaction -- either a purchase or a sale. However, if the contract already has 1,000 contracts of open interest, then the trade might be a closing trade. In order to find out, check the market the next day. If the open interest has dropped to zero, the trade was a closing transaction. If it has increased to 2,000, the volume was part of an opening transaction.
TRADING LEVEL QUESTION
After looking at my broker's website, I noticed that customers get assigned different level ratings indicating what types of options they are allowed to trade in their account. I haven't opened an account yet, so I was wondering what they look at and how they determine this rating. Is it possible to get assigned a level that prevents you from doing trades you would have liked? Thanks.
Brokerage firms are required to know their customers and make sure that each account is not taking on too much risk given the individual's financial resources, experience, and knowledge. Most of the information is gathered at the time the account is opened. Before trading options, individuals must complete both a new account form and an options approval document. The new account form will provide information about personal and financial background. In the options approval document, the trader lists past trading history and experience, as well as the types of strategies they hope to trade in the new account.
Based on the information in these documents, the brokerage firm will assign a ranking or level to the individual trader. The brokerage firm's compliance department will review the information and make the appropriate decision. Brokerage firms can, and often do, deny requests to trade certain strategies if the investor is not deemed to have enough experience and/or financial resources.
The assignment of ratings or levels can vary from one brokerage to the next, but all brokers generally use the same guidelines. For example, level 1 approval allows basic strategies like covered calls and protective puts. More complicated or risky trades require a higher level of approval. Selling uncovered calls is considered extremely risky and requires the highest approval rating -- a level 5. Only traders with a great deal of experience and significant financial resources can receive approval for level 5 trading. Spreads and straddles generally fall in the middle --that is, traders with level 3 approval can use strategies like straddles and strangles, as well as bull or bear spreads.
In sum, it's really up to the brokerage firm to determine what level of options trading approval is right for you. This will protect the firm by ensuring that their customers are not taking on excessive risk, given their experience and financial background. This will also protect less experienced traders from taking on excessive risk that might result in financial losses or even wipe out their trading account.
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