Size Counts

Percentage movement is meaningless in stocks. Own 1000 shares of a $10 stock and you have the same $10,000 tied up as owning 500 shares of a $20 stock. The same $10,000 buys you 100 shares of a $100 stock. If any of these stocks move up 10%, a $10,000 position would increase to $11,000.

Percentage movement for option is essential. Stocks need to make decent price moves in order for its options to have their prices affected.

Strike price choices on a $10 stock maybe limited to $7.50, $10, and $12.50. Going two strikes In or Out of The Money (ITM, OTM) would add the $5 and $15. Both of which are 50% from the current price.

The $20 stock would have $17.50, $20 and $22.50 strike prices. If two strikes In or Out of The Money (ITM, OTM) are available, they would only be 25% from being At The Money (ATM).

The $100 stock’s strike price availability would all be closer in terms of a percentage. The $90 and $110 choices would be two In or Out (ITM, OTM), yet they would only be 10% In or Out (ITM, OTM).

If a $100 stock moves 10%, it will pass through two strike prices. If it moves 10% down, it would pass through the $95 and $90 strikes. If it moved up, it passes through the $105 and the $110 strikes.

If a $20 stock moves 10% it comes close to moving one strike. It would still be $0.50 away from either the $17.50 or the $22.50. Close, but not close enough.

A 10% move on a $10 stock doesn’t get the price much closer at all to the next strike price. Less expensive priced stocks need bigger percentage movements.

The significance of strike price distance versus stock prices as terms of a percentage should be clearer. All equal percentage price movements affect all stocks equally, they do not affect options the same. A 10% move is a big thing to options on high priced stocks, but lower priced stocks require larger percentage moves to affect their options.

If a stock’s price is too low, you may consider buying the stock as opposed to trading options on it. You should certainly rule out trading Out of The Money (OTM) options on them. Match the strategy to the stock price.

Margin requirements vary on plays. Buying options requires the money to pay for them. Buying stock either requires full payment, or you may purchase them on margin. (Check with your broker for specific margin requirements.) Generally speaking stocks need to be around $5 minimum in price to be optionable. In such case the typical margin is 50%. That is, you need to have half the money available, your broker will loan you the other half.

When you sell options, you will need to put something up as collateral. With Covered Calls, the most often sold option, the collateral is the stock the option is written against. You either need to pay for the stock in full, or buy it on margin. By putting up only 50% of the cost and selling the option and receiving 100% of the premium you may more than double your return.

Naked Puts have more aggressive margin still. Many brokers only require 25% security for the value of the stock. Successful Naked Put selling may have less commissions tha
Covered Calls. Naked Puts done right cost one commission versus Covered Calls three.

Always run through different strategies and pick the best one depending on your risk tolerance, account size and your expected move in the asset.