Over the last couple of years, we've heard of several unintended consequence of various economic policies. Recently, I was thinking about an example of an unexpected consequence of a market reality.
In 2005, Hovnanian Enterprises Inc's (HOV) stock traded north of $50.00 for most of the year, reaching a high of $73.40. In 2006, Office Depot (ODP) spent most of the year above $35.00, reaching a high of $46.52. In early November, 2011, both stocks traded under $2.00.
Those prices don't leave many opportunities for options traders. Rules in place at the options exchanges regulate the strikes for options, but after the steep declines of a few years ago, those exchanges have amended their rules. Now you can find some strikes on some underlyings in $0.50 increments. The Options Industry Council, the educational arm of the Options Clearing Corporation, described a $0.50 strike program as including low-cost securities that met certain requirements for options volume across a three-month period. Different sources list different security prices and different intervals for the $0.50 strikes, from $0.50-3.00 in one source and between $0.50-6.00 in another I found. It's probably best to check a specific exchange for alerts or infomemos listing the securities included in this program at any one time. For example, as of November 3, First Bankcorp Puerto Rico (FBP) was priced at $3.93. NOV 11 options were priced in $0.50 increments only up to $4.00, but DEC 11 options were priced in $0.50 intervals up to $5.00. Similarly, Zale Corporation (ZLC) was priced at $3.94, and the option chain displayed options priced in $0.50 increments up to $5.00. After that, the strikes were listed at $7.50, $10.00, etc.
Because of the conditions that must be met, the securities eligible for the $0.50 strike program will change from time to time, and it appears that the program's parameters might, too. When researching this article, I found an even more intriguing possibility: The CBOE's senior attorney has submitted a proposed rule change that would ask the SEC to allow $0.50 strikes for much higher-priced securities. The form asks the SEC "to permit the listing of strike prices in $0.50 intervals where the strike price is less than $75, and strike prices in $1.00 intervals where the strike price is between $75 and $150 for option series used to calculate volatility indexes." The purpose? Because the volatility indices are calculated using a finite number of data points, they're subject to errors in calculation. The errors in calculation would decrease if more data points were available.
In the document submitted to the SEC, the CBOE used the example of the USO options used to calculate the OVX, the CBOE Crude Oil ETF Volatility Index. The CBOE argues that the VIX is recognized as an accurate and reliable volatility measure, but that its calculation typically involves 200 to 250 SPX series on a typical day. This large number of data points allows for its reliability, with more data points smoothing out the calculations. By comparison, the USO's strike separations are a much greater percentage of the USO's price, and "only about 40 to 60 USO options are used to calculate OVX on a typical day" (7). The CBOE assures the SEC that the exchange has the systems capacity to handle the additional strikes if the $0.50 and $1.00 strikes are allowed (14). The CBOE also assures the SEC that this isn't going to "result in a material proliferation of additional series" since their plan is to limit it to those classes used in volatility calculations (15).
How useful are these $0.50 strikes to you and me? Before you decide to trade them, check open interest, volume, and--just as importantly--bid and ask sizes and prices--to determine the answer to that question. Fifteen days before expiration, ODP's NOV11 2.50 strike call had an open interest of 3,043, but bid size at the PHLX was 2,063 and ask size, 1,844. By comparison, an SPX NOV11 SPX call, a much closer-in strike proportionately, had an open interest of 40,985. However, CBOE bid size was only 2 and ask size, only 136. The ODP NOV11 2.50 strike was obviously more actively traded.
But if a trader were bearish ODP, could she hope to sell a 2.50/3.00 spread, and would it be a good idea if one could? I don't know, but I can tell you that if ODP is approaching the 2.50 strike a week before expiration, it certainly wouldn't be likely that one could buy in the whole spread, but would rather have to buy in the sold call without hoping for a contribution from the long 3.00 strike. There would likely not be any bid size for that 3.00 strike.
The CBOE's attorney might be assuring the SEC that there won't be a "material proliferation of additional series," but if this rule change is approved, we can probably look for $0.50 strikes on the options used to calculate at least some of the indices found on this list. If the change is approved, the biggest effect for options traders will likely not be the existence of the $0.50 strikes but, rather, the more reliable volatility indices linked to those underlyings.