Sunday, September 19, 2010

Wall Street Journal Article!!

A New Wrinkle in Options

Short-term weekly option contracts are gaining traction among investors—even though their volatility can make it easier to lose money.
Unlike standard option contracts that expire in a month or more, weekly options can be a cheaper way to make bets around near-term events, such as corporate earnings or a government report. Investors can also use them as a way to generate income or offset the costs of holding longer-term options.
But while weekly options can provide investors with more flexibility, they also may be more volatile. Investors have to be right on their bets almost immediately. If they are wrong, that could translate into losses much more quickly. Trade them frequently and transaction costs can add up, too.
Trading in weekly options contracts took off this summer after changes to the naming convention of options made it easier for U.S. exchanges to offer them. Today, there are 30 weekly options across popular stocks such as Apple Inc., General Electric Co. and Microsoft Corp., indexes such as the Standard & Poor's 500 and exchange-traded funds. A year ago, there were only four.
The changes come at a time when the options industry is moving to expand the types of products available to investors. The Chicago Board Options Exchange, for example, recently asked the Securities and Exchange Commission to grant it permission to list daily options that would have expiration terms between one and four business days. Last week, the CBOE Futures Exchange announced plans to offer weekly options contracts on VIX futures. (The VIX is an index that tracks volatility in the stock market.)
A Surge in Interest
Brokerage firms such as TD Ameritrade Holding Corp. and TradeKing are seeing a surge in investor interest and have ramped up their educational marketing content. In July, for example, trading in weekly option contracts hit a one-day high of 22% of total options volume at TD Ameritrade.
An option is a contract that gives the owner the right to buy or sell an asset at a certain price by a certain date. Investors who buy "call" options, for example, pay a premium for the right to buy an underlying security at a set price on or before a specific date. Sellers of call options, by contrast, earn a premium and are obligated to sell the underlying security at a set price—if the owner of the option chooses to exercise the contract.
Many investors are using weekly options to exploit news events, such as a product announcement or home-sales number, says Lynne Howard-Reed, director of business development at the CBOE, which introduced weekly options on a handful of indexes in 2005.
Cheaper Exposure
Weekly options are also a cheaper way to get exposure to expensive stocks, says Steve Quirk, head of the active-trader group at TD Ameritrade. Because of their short duration, they cost significantly less than standard options.
Say you own shares of Google Inc., which are trading at about $490. For about $11, you could buy a "put" option, which allows you to sell the stock if the price falls to below $480 at any point in the next month. But for about $2, you could buy a put that allows you to sell the stock if the price falls to below $480 in the next week.
If the stock went up during the week, that weekly option would expire worthless and you would be out the premium. But if the stock fell below the option's strike price, the investor could make a big profit.
You can buy a weekly call option with a strike price 1% above the price of the underlying stock or index for about half a percent of their values, says Jim Bittman, senior instructor in the Options Institute, the CBOE's educational division. "A 2% move up could double your money—but it obviously has to be in the right direction," he says.
By their nature, weekly options are generally used by active traders, but even investors who trade less frequently can still use them to manage their risk during earnings periods or other corporate events, says Ed Boyle, who runs NYSE Euronext's U.S. options business.
At TradeKing, the most popular trade among retail investors is to sell weekly call options on stocks as a way to earn extra income, says Brian Overby, senior options analyst at TradeKing. While the premiums investors earn are smaller than those on monthly options, they can make sense for investors who believe the stock is likely to remain stable and wouldn't mind selling it if they had to.
"If the stock didn't move at all, you'd get a better return on selling four weeklys than selling a one-month option," says Mr. Overby. But if the stock takes a dive, the smaller premiums wouldn't do as much to offset the losses on the underlying security, he says.
Adam Beaty of Houston recently started selling weekly put options on Inc. "With the weeklys, everything is a little bit cheaper," he says.
The downside, he says, is that he has to take on a little more risk. Under his previous strategy of selling monthly put options, he would be obligated to buy Amazon stock, currently trading at about $148, only if the stock dropped by about 17%. With weekly options, he figures he would have to buy if the shares fell about 6%. "It's just good for the extra money," says the 24-year-old, who helps run a commercial pest-control business.
'Diagonal Spreads'
Another strategy is to combine a weekly option with a standard monthly option in the same trade, which is known as a "diagonal spread" and might appeal to those who are neutral to slightly bullish on a particular stock or index.
The strategy involves buying a longer-dated call option and selling a weekly call option with a higher strike price to help offset the cost of holding the longer-term position, says the CBOE's Mr. Bittman.
If the market doesn't move much or declines, the income from the weekly option could help offset the decline in value of the monthly call option. The trade-off is that investors could pay more in trading costs and might not earn as much as they could otherwise if the market shoots higher.

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