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.
- 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 Chicago Board Options Exchange (CBOE) rules, there are five criteria that a stock must meet before it can have options as of December 2020.
- 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.
A company cannot have options traded on its stock until at least three business days after its initial public offering (IPO) date.
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 December 2020, 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 around 500 million; that volume grew to more than 1.5 billion contracts in 2005.
By the end of 2017, the Options Clearing Corporation was the world's largest derivatives clearinghouse and reported clearing 4.5 billion contracts for the year. Investors have discovered the huge cost efficiency in using the leveraging power of options to increase their potential returns and hedge their risks. In 2020, the OCC cleared a record 7.52 billion contracts.
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.