A new opportunity offered by some exchanges provides option traders with a way to enter into positions that may be more appropriate for their risk constraints. Here is how these new securities, called mini options, differ from the traditional option contract, and what the potential advantages are.
Similar option basics
The features of mini options are almost identical to traditional options. Both types of options grant the holder the right, but not the obligation, to buy or sell an underlying security. However, mini options control just 10 shares of the underlying asset, compared with 100 shares controlled by a traditional option. The small contract of the mini option results in potentially different initial outlays, a potentially different number of shares that are being bought and sold, and potentially different costs.
Let’s consider an example to illustrate these dissimilarities: A traditional call option grants the buyer the right to buy 100 shares of XYZ Company. Assume that XYZ Company is trading at $100 a share. In order to buy 100 shares of XYZ Company stock, an investor would need $10,000 ($100 a share times 100 shares). Using options, an investor could purchase a call option—which grants the right to buy 100 shares at a specified exercise price. A 98 call option, for example, would grant the buyer the right to buy 100 shares of XYZ Company at $98 a share.
The cost of purchasing this right to control the 100 shares is known as the premium. Assume that the 98 call option had a premium—the cost of one contract at this price—of $3. The cost of this transaction would be $300 ($3 premium times 100 shares).1 Compare that with the $10,000 it costs to buy the stock outright.
The maximum potential loss for the buyer in this transaction is the cost of purchasing the option, which is $300. Of course, the value of the option contract might change as the price of the underlying security fluctuates, because of the passage of time and changes in volatility.
Alternatively, suppose the desired position is not 100 shares of XYZ, nor an initial outlay of $10,000, or even $300. A mini option provides an alternative. An investor could purchase a mini option, potentially reducing both the number of shares controlled as well as the initial outlay. Assume a 98 mini call option had a premium of $3. The cost of this transaction would be $30 ($3 premium times 10 shares).
Mini options can provide access
The fewer number of shares controlled by the mini option can reduce the cost of entering into a desired position, compared with the traditional contract. For investors, the relatively smaller outlay may reduce some of the risks present in the traditional, larger option contract.
Also, mini options can help provide access to higher-priced stocks, where buying even one share or a single traditional option contract can be a relatively large expenditure. Currently, mini options are only available for Google Inc. (GOOG), Apple Inc. (AAPL), Amazon (AMZN), SPDR S&P 500 (SPY), and SPDR Gold Trust (GLD). The share price for the companies is significantly higher than almost all others.
A traditional option contract on Google, for example, could amount to a relatively large position. One traditional Google call option—when the share price is trading at $900 per share—might control about $90,000 worth of stock ($900 times 100 shares). This can be a very large position for many investors.
The mini option offers an alternative. A mini option—which controls just 10 shares—might translate to a $9,000 stock position. This is a significantly more manageable trade size for many investors. If you were interested in trading options on Google, you could buy an at-the-money mini call option on Google with a strike price of 900 that has a premium of $10, for a total cost of $100 ($10 premium times 10 shares), excluding commissions.3
A new option
It’s important to note that mini options, while becoming more popular, are a new product that was recently released, in March 2013.4 As a result, there are additional risks—including the existing risks of using traditional options—associated with mini options. It is important to recognize that the smaller amount of shares controlled by mini options does not mitigate the inherent risks associated with option trading.
Furthermore, because these types of options are very new, there is not nearly as much liquidity, and so the bid-ask spreads for many mini options can be quite large compared with more active, traditional option markets. Consequently, the cost of exiting a position could be more expensive than anticipated. To that point, commissions can affect the trade to a greater extent because of the typically smaller position.
If mini options continue to grow in popularity, as they have been, some of the unique risks may be alleviated. Mini options are a new, and potentially dynamic, way to establish positions using options. Consider the smaller option contract if you’d like less exposure to a stock than is provided by traditional options.