Anyone who trades the SPX, especially with strategies employing out-of-the-money strikes, needs to be aware of the "Power of Multiple of 25." Is that some secret algorithm written by programmers and executed by computers?

Not at all. No secret. No algorithm. It's a phrase I made up. I'm referring to the importance of out-of-the-money and deep-in-the-money strikes that are multiples of 25. If, on January 25, I employ BrokersXpress to call up a FEB SPX option chain and look at open interest on deep-in-the-money calls or far out-of-the-money puts, I'll soon notice something striking about the open interest.

Deep-in-the-Money FEB SPX Calls, showing Volume, Open Interest, and Strike:

It soon becomes obvious that the biggest open interest levels--and the only volume--can be found in strikes that are multiples of 25. This is true for the OTM puts, too. The 1150, 1175 and 1200 puts have open interest of 81,291; 55,612; and 147,075; respectively, while nearby strikes have at most open interest of 21,254, with most other strikes having far less than that. Daily volume for those puts was 4,044; 559; and 6,738; respectively, while most other strikes had daily volume in the hundreds or tens, with the exception of the 1160 and 1180 strikes.

Long-time option traders understand why that open interest is higher in strikes that are multiples of 25. A look at the DEC 2013 options provides a clue. In the range we're studying in the above example, the only strikes available are the 1150, 1175, and 1200 strikes, appearing in 25-point intervals. Therefore, institutions and big money employing options for long-term strategies will be using options that are multiples of 25. As those options draw nearer to expiration, they accumulate more and more open interest. Something else begins to happen. Especially when they draw within a couple of months of expiration and theta-related decay will work faster, institutions are likely to be rolling their original trades into further-out options, creating more volume. Some retail traders will be trading them, too, with the thought that the higher open interest and volume will make getting in and out of those options a bit easier.

What happens if you have a credit spread, butterfly or some kind of ratio backspread that employs one of those options and another option that is perhaps not a multiple of 25? If you're watching the theoretical profit/loss chart on such a spread, you may sometimes feel as if you're straddling the fault line when an earthquake threatens. There may be actual bids and offers in the strikes that are multiples of 25, while the surrounding strikes, likely the ones where you've got the other leg of your spread, may have prices based on theoretical calculations. You may see one leg of your spread suddenly widen or narrow, with your profit or loss changing dramatically as a result.

Seemingly changing. Does the executable price for that spread or complex order really change that much?

About 3:33 pm Eastern time on January 25, I used midprices to calculate the values of 10-point spreads in SPX puts, obtaining the following results:

1140/1130: $0.60
1135/1125: $0.85
1130/1120: $0.35
1125/1115: -$0.10
1120/1110: $0.35

I had 1125/1115 spreads at the time. Does anyone believe that I could close out those sold spreads, selling them for a -$0.10 debit or a +$0.10 credit? Does anyone believe I would have been able to roll up those spreads into the 1135/1125's and obtain a $0.85 credit, even if the market makers were feeling generous that day and letting me in and out at the midprice or mark?

Obviously, something was going on with those 1125's, a component of both those spreads. Other spreads were likely priced theoretically but someone had put in an order for the 1125's. That 1125's actual (temporary) midprice was being paired against a theoretical value for the 1135's and 1115's. The profit-loss chart certainly showed that I was theoretically making a lot of money on those spreads I had sold for a credit and could now buy back for a credit, too. My theoretical profit shot way up suddenly. It was fun, but it wasn't real. It wasn't an executable price. I looked but wasn't fast enough to fast enough to see the actual order before the anomaly disappeared and I was back to my regular amount of theoretical profit.

We sometimes have to probe for executable prices. I have long experience trading the SPX and so know what prices "should" be for a certain spread. That helps, but sometimes I just have to put an order in and see if it fills. I've heard some traders say that they put in an appealing limit order for a single contract to see if it fills, cancelling and replacing the order as they probe for the real price, and then immediately place an order for the rest of the spread if it fills at a satisfactory level. I know other savvy traders with good connections who either call down to the CBOE or get their brokers to do so. I don't have those kinds of connections. I could maybe get a broker to do it once or twice, but I don't trade the volume that would make a broker happy about doing it for every trade.

I've also known other traders who panicked and made some unneeded adjustment to their already placed positions. Be aware that of this power of 25 to momentarily scramble profit/loss charts or your plans for an entry or exit, if you're pitting one of those strikes against another one that's priced theoretically. This phenomenon might not be as problematic in other underlyings, but a check of the furthest-out options for your preferred underlying should give you some idea of which options are most likely to be impacted.