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January 3, 2006

A Short-Term Options Battle: The make or break point for equity traders

By Mark Longo

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  • A Short-Term Options Battle: The make or break point for equity traders

This month's column is for all the spendthrifts out there. If you're like most equity traders, then your primary focus is on earnings calls, Federal Reserve announcements and other events that can significantly impact your portfolio. While every trading day is important, these are the events that can make or break your year. Unfortunately, when it comes to trading options on these specific events, your choices are limited. Most options are only available in denominations of months or years. That is a lot of extra volatility and interest premium to incur just to trade a single event. However, after decades of ignoring this problem, the options markets are coming to the rescue with a host of short-term products that may forever change the way you look at trading.

The CBOE was the first to launch a short-term product when it announced weekly SPX and OEX contracts. Its newfound interest in short-term traders was sparked by recent developments in the endless war between the options exchanges. In this increasingly brutal conflict, proprietary products have become the weapons of choice. Exchanges are constantly on the lookout for new ways to expand their monopoly products. The CBOE already owns a proprietary license on S&P options products. This license has given it control on the world's best-known index and allowed it to survive the steady erosion of its equity options market share. However, its primacy in the S&P market was challenged earlier this year. That's when the International Securities Exchange (ISE) applied to list options on the SPDR ETF (see March's Options Trader column for details). The result was a feeding frenzy on SPDR options that gave every exchange a chance to garner a piece of the lucrative S&P pie.

The CBOE Strikes Back

Now, in an effort to regain some of its lost volume, the CBOE is making a foray into the world of Weeklys. "The CBOE's Weeklys offer an innovative way for customers to efficiently take advantage of news-driven market moves and short term trading strategies," said CBOE Vice Chairman Edward T. Tilly. "Weeklys will build on the liquidity provided by CBOE's deep pool of experienced and well-capitalized index traders, and will add a whole new dimension to this already versatile option product," he added.

The Weeklys share many of the distinguishing characteristics of existing SPX and OEX contracts. Both Weekly contracts are cash-settled, with the Weekly SPX offering European-style options and the Weekly OEX offering American-style options. However, there are a few significant differences with the existing products. As their name implies, the Weeklys expire at the end of the trading week instead of every month or year. In order to reduce confusion with the original products, no Weeklys will be listed that expire on the third Friday of the month. In addition, each Weekly will be restricted to five strike prices. These will include two out-of-the-money strikes, one at-the-money strike and two in-the-money strikes. Unlike the existing products, no new series will be added between listing and expiration.

And Then There Were Two