There are additional risks involved in options, so options exchanges have put specific requirements in place before a company's stock can be listed for options contracts. Individual companies have no say on whether or not options on their shares trade on an options exchange. The decision to list equity options for a particular equity is entirely at the discretion of the exchanges themselves.
Key Takeaways
- Before options can be written, a stock must be properly registered, have a sufficient number of shares, be held by enough shareholders, have sufficient volume, and be priced high enough.
- The specifics of these rules can change, but the general idea is to protect investors.
- Options are relatively new, and there was a time when there were no options on any stocks.
- Even if options are available, they might not meet your own risk requirements.
The Five Requirements
Under Cboe Exchange (Cboe) rules, there are five criteria that a stock must meet before it can have options as of April 2022.
- The underlying equity security must be a properly registered NMS stock.
- The company must have at least 7,000,000 publicly held shares.
- The underlying stock must have at least 2,000 shareholders.
- Trading volume must equal or exceed 2,400,000 shares in the past 12 months.
- The price of the security must be sufficiently high for a specific time.
Options exchanges, such as the Cboe, will not allow any options to be traded on the underlying security if a company fails to meet even one of these criteria. However, meeting all of the criteria doesn't guarantee acceptance.
Price Requirements
The price rules are the most critical in many ways. Penny stocks and other low-priced securities often suffer from bad reputations, which could be further hurt by speculation in the options market. What is more, stock splits could create more shares and get around most of the other rules without the price rules.
The price requirements are somewhat more complex than the others. Price rules continue to evolve to meet the changing demands of market participants while still protecting investors. Penny stocks are already volatile and subject to price manipulation, so some care must be taken in extending options to low-priced securities. As of April 2022, there were two types of securities and corresponding price requirements.
Price Requirements for Covered Securities
Most major U.S. stocks are covered securities and face less stringent price requirements for options trading. These stocks must close at $3.00 per share or more over the last three days before options can be written. The time restriction here is what prevents options from being traded on stocks for the first three days after an IPO.
Price Requirements for Other Securities
The rules are somewhat more strict for other securities. If a security is not covered, then it must close at or above $7.50 for more than 50% of business days during the last three months before options can be written. Securities that are not covered tend to be more volatile, so these rules help to ensure that they genuinely meet all requirements.
A Brief History of Options Clearing and Volume
It is hard to believe today, but there was a time when no stocks had options. Despite being around since the 1970s, options contracts only became massively popular in the 21st century.
The Chicago Board Options Exchange (CBOE) opened its doors in 1973 and became the world's largest options market. On the first day, just over 900 contracts exchanged hands-on only 16 stocks. In the year 1999, the total volume of options contracts on U.S. exchanges was about 445 million; that volume grew to more than 1.3 billion contracts in 2005.
The Options Clearing Corporation is the world's largest derivatives clearinghouse and reported clearing 9.3 billion contracts for the year 2021. Investors have discovered the huge cost efficiency in using the leveraging power of options to increase their potential returns and hedge their risks.
Personal Risk Requirements
Many options listed on exchanges might not meet your risk requirements. As derivatives, they have a partly deserved reputation for being more dangerous than their underlying securities. However, the truth is that options can actually reduce risk when used judiciously. They can even be less risky than equities in certain situations because the financial commitment is lower.
Furthermore, options are more dependable than a stop-loss order. Finally, options open up a variety of alternatives for strategic investors to meet their investment goals through the use of synthetic options.
FAQs
The underlying equity security must be a properly registered NMS stock. The company must have at least 7,000,000 publicly held shares. The underlying stock must have at least 2,000 shareholders. Trading volume must equal or exceed 2,400,000 shares in the past 12 months.
What is level 5 options trading? ›
Options Account Trading Level 5
Trading level 5 allows you to write call and put options without first owning the underlying stock. This is where you get to "play banker" to other options traders who are speculating through call and put options buying.
How is price determined in options trading? ›
Key Takeaways. Options prices, known as premiums, are composed of the sum of its intrinsic and time value. Intrinsic value is the price difference between the current stock price and the strike price. An option's time value or extrinsic value of an option is the amount of premium above its intrinsic value.
What is the minimum price for option trading? ›
You don't need a considerable sum of money to become an options trader. You can start small with a capital of less than Rs 2 lakhs too. However, as you start small, you need to be a careful trader so that you can cut down on the possibility of losses and enhance the return potential of your trades.
What is the golden rule of trading? ›
Run profits, not losses: If a profitable trade wants to become more profitable, let it be. If a trade is going wrong, why watch it get worse. Recovering losses is even harder work.
What is the best option trading level? ›
Most options brokers assign trading levels from 1 to 5; with 1 being the lowest and 5 being the highest. A trader with a low trading level will be fairly limited in the strategies they can use, while one with the highest will be able to make pretty much whatever trade they want.
What are the six factors that determine an options price? ›
There are six factors affecting the price of a stock option:
- The current stock price, S 0.
- The strike price, K.
- The time to expiration, T.
- The volatility of the stock price, σ
- The risk-free interest rate, r.
- The dividends that are expected to be paid.
An option's price depends on how long it has to run to expiry. Intuitively, the longer the time to expiry, the higher the likelihood that it will end up in-the-money. Hence, longer dated options tend to have higher values, regardless of whether they are puts or calls.
What factors affect the price of an option trading? ›
The main factors affecting an option's price are the underlying security's price, moneyness, useful life of the option, and implied volatility.
Can I trade options with $100? ›
If you're looking to get started, you could start trading options with just a few hundred dollars. However, if you make a wrong bet, you could lose your whole investment in weeks or months. A safer strategy is to become a long-term buy-and-hold investor and grow your wealth over time.
Due to high volatility in the options market, Robinhood requires you to set a limit price for all options trades. With a buy limit order, you can set a limit price, which should be the maximum price you want to pay for a contract. The contract will only be purchased at your limit price or lower.
What are option strike price rules? ›
The strike price of an option is the price at which a put or call option can be exercised. A relatively conservative investor might opt for a call option strike price at or below the stock price, while a trader with a high tolerance for risk may prefer a strike price above the stock price.
What is the 5 3 1 rule trading? ›
The number 5 stands for choosing 5 currency pairs that a trader would like to trade. The number 3 stands for developing 3 strategies with multiple combinations of trading styles, technical indicators and risk management measures. The number 1 guides traders to choose the most suitable time for trading.
What is the 3 5 7 rule in trading? ›
The strategy is very simple: count how many days, hours, or bars a run-up or a sell-off has transpired. Then on the third, fifth, or seventh bar, look for a bounce in the opposite direction. Too easy?
What is the 123 rule in trading? ›
The 123 setup consists of three pivot points. The confirmation of the 123 reversal pattern lays at Pivot Point 2. The target when trading a 123 formation is at a distance equal to the size of the pattern, applied beyond Pivot Point 2. Your stop loss should go beyond Pivot Point 3.
What are the levels of options trading? ›
Option Trading Approval Levels by Broker
Most brokers currently offer 3 levels of options approval, with “Level 1” being the most basic (covered calls) and “Level 3” the most advanced (selling options naked). However, most traders will find everything they need under “Level 2”.
What is advanced diploma in options trading level 5? ›
For candidates looking to acquire professional competency to trade options, the Level 5 Advanced Diploma in Options Trading provides a deep immersion in trading strategy as well as advanced options theory and practice.
What is IV rank in options? ›
What is IV Rank? Implied Volatility Rank or IV Rank is a measure to determine how cheap or expensive stock or ETF options are based on their implied volatility (IV). It compares the current implied volatility to the implied volatility of the underlying over the past 365 days.
What does Level 1 options trading mean? ›
Trading level 1 is the lowest level and it typically only permits two types of trades: a covered call sold against a long stock position in your account and a cash-secured put, which is selling a put and simultaneously setting aside enough cash to buy the stock.
