Bringing Deltas To The Masses
The Siren Song of Leverage
Options have always been popular tools with speculators. The siren song of leverage is irresistible for investors and traders looking to profit on dramatic moves in stocks and indexes. Unfortunately, one obstacle has always been difficult for these market participants to overcome - cost.
The inherent leverage of options provides much more bang for your buck than trading the underlying. However, the contracts that offer the most bang for your buck (ATM options) can also be prohibitively expensive for many traders and investors. Gamma and Vega are wonderful things, but they usually don't come cheap.
Chasing the OTM
So what does your average trader, investor or fund manager do when they can't afford to load up on juicy at-the-money (ATM) options? They move their aspirations a few notches up or down the strike chart until they find an out-of-the-money (OTM) option that they can afford to purchase.
Of course, anyone who has traded options understands that OTM options are cheap for a reason. These contracts offer little gamma or vega and most of them eventually expire worthless. That is the great catch-22 of the options market. Everyone is lured to options by their leverage and comparatively low cost. However, once they begin establishing positions, many of them are forced to the OTM strikes for economic reasons.
This can be particularly disheartening for new options investors who are making their first tentative steps into the options market. The poor success rate of OTM options is usually enough to sour them on options forever.
AMEX To The Rescue?
One exchange in particular is looking to alleviate that problem with a series of new products aimed at retail and small investors. The AMEX is planning to launch a series of binary options (See "Let's Talk About Binary Derivatives" for more information on binary products) on a variety of popular equity and index products.
"Retail traders tend to buy OTM, lower delta calls because they arecheaper. But then they don't get the performance that they desire," says Michael T. Bickford, Senior Vice President of Options at AMEX. "Our contracts, however, will have a full payout value of only $100. We hopethe lower price of these products will help shift that retail activity down tothe ATM, higher delta options that provide better performance."
There are currently 86 stocks that qualify for these new binary options. Equities and ETFs will also qualify for the binary treatment, including the QQQQs, opening up those markets to retail investors. These binary options will function in a very similar manner to traditional options, only in much more straighforward manner and at a much lower cost. If the underlying expires at or beyond the strike in question, then the binary options will payout their full $100 value. If not, then they will expire worthless.
(For example, if XYZ stock closes at $51 on expiration, the binary XYZ 50 calls would be worth their full payout value of $100. However, the XYZ 52.5 calls would be worthless. )
By bringing the prices of ATM options contracts down below $100, the AMEX may very well revolutionize the way retail traders use options.
Of course, as with most things in the options world, change did not come easy. The SEC has dogged AMEX's steps throughout this entire process and continues to delay the entrane of these products into the market. "This has been a very lengthy ordeal for us. We began this process two and a half years ago and we still have 4-6 months ahead of us, but we expect eventual approval from the SEC," says Bickford.
Traditional calls and puts gauge the probability that the underlying will expire at or beyond a certain price.
"We are looking to expand into binary options. These would pay $100 if they paid out...these binary options trade huge size in the OTC market and we ar elooking to carve out a piece of that and expand it to retail. The small price of our contracts will help to drive retail flow to this product. We have 4-6 months ahead of us on these, but we expect approval from the SEC. There will be 86 stocks that qualify for these new products...We began this process 2 and a half years ago...Equities and ETFs will qualify for this binary treatment including the QQQs, which will give the retail customers more access to that market. ...Retail traders tend to buy OTM, lower delta calls because they are cheaper and then don't get the performance that they desire. We hope the lower price of these products will help shift that activity down to the ATM, higher delta options that provide better performance." - Michael T. Bickford, Senior Vice President, Options, AMEX.
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