Q&A

Explore Your Options

with Tom Gentile

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.

MAXIMIZING YOUR HEDGE WITH MINIS
Here’s a question I get asked at almost every option event at which I teach: “Tom, how do I hedge 10 shares of Google?” Until recently, my answer used to be, “Get 90 more shares, and then we can talk.” But as of March 18, 2013, my answer has changed.

On that date, the Chicago Board Options Exchange (CBOE) launched a new product called mini-options aimed at the smaller investor (in this case, an investor who holds less than 100 shares of some higher-priced stocks) who is looking to hedge odd-lot securities. What exactly is a mini-option? First, to review, a regular-sized equity option contract gives the buyer the right, but not the obligation, to buy 100 shares of the underlying asset at a set price for a set period of time. Regular-sized options have many strike prices both above and below the stock price. Regular options could have as little as one week to expiration or as long as years. A mini-option represents one-tenth of the value of a regular-sized option. Thus, a mini-option contract is good for 10 shares of stock and is in many ways like standard options.

Now, before you go out and analyze your odd-lot portfolio, you should know that the launch by the CBOE is a pilot program and mini-options are offered only on the following stocks:

AAPL, AMZN, GOOG, GLD, SPY

These mini-options, like the regular-sized options, offer various strike prices and the same expiration dates as their larger counterparts. They are similar to their bigger brother, but smaller. I can think of two segments of the trading and investing community that may look to mini-options as a viable product for their portfolio:

The odd-lot investor. This is the person, such as my mother-in-law (let’s call her “MIL”), who buys 10 shares of Google (GOOG) because that’s all she wants to spend on it in her portfolio. She likes to buy and hold GOOG a month before earnings and then sell after earnings. Of course, 10 shares of GOOG at current prices are valued at around $8,000. That might not be much to you, but to her it represents a lot of money. Before the mini-option existed, she couldn’t hedge her stock position, but with mini-options, she now has several strategies available to hedge this particular position if she intended on keeping it longer than a few days. These possible strategies include:
- Covered call option—MIL could purchase her 10 shares of GOOG at $800 per share and simultaneously sell one mini-option contract with one month to expiration on GOOG at $800, and collect premium for the sale, which, at the time of this writing, was $30. She now has $30 of protection for her GOOG stock, and even if GOOG were to stay at $800, she keeps the premium collected at expiration. The bad news is that she has also capped her reward to the amount of premium collected, so if at earnings, GOOG jumped to, say, $900 a share, she is obligated to sell the stock at $800.
- Married put option—In this case, MIL could protect her 10 shares of GOOG with a mini-option purchase of GOOG puts. If she bought one mini-option with one month to expiration at a strike price of $800, she would end up paying 30 points of protection for GOOG. This is $300 to protect $8,000 of stock for 30 days. The good news is twofold: if GOOG has good earnings and the stock jumps to $900, MIL gains 100 points on the stock, and even though the put protection cost $30, she still nets 70 points of profit. If Google’s earnings aren’t up to expectations and the stock falls 100 points, the put she bought gives her the right to sell GOOG at $800. The protection that cost 30 points saves her 100 points in the stock drop. The problem is if GOOG stays in a sideways range, it will cost her unneeded protection, but still gives piece of mind.
- Collar strategy—This is a combination of the two previous strategies, where you buy the stock, buy a put, and sell a call simultaneously. This strategy takes the advantages and disadvantages of both of the previous strategies: it completely protects the stock, but the rewards are minimal.
The option speculator. The second type of investor that comes to mind when I think about who may benefit from mini-option trading is the speculator who wants to try options, but on a lower scale than the standard-size contracts. With mini-options, you can still use any number of option strategies, including vertical and horizontal spreads, exactly the way that you could with a standard option, but with 10% of the cost and risk! At Optionetics.com, we offer a list of option strategies you can use with the new minis. Just don’t tell my mother-in-law about them; I would have a full-time job teaching her about options!

Good trading!

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