Lessons from the Pros

Un-lubricated Quarterly Options (or) Squeaky Quarterly Options

Having received many interesting emails after my initial article on the Weak Weekly Options, I have gotten a request to explain my take on the Quarterly options. One of the ways to address them is simply by comparing them to the Weekly ones as well as to the regular options.

The Quarterly options usually appear on the option chain four times annually; logically, one set of Quarterly options for each Quarter. Figure 1 shows the option chain on the QQQQ, the ETF (Exchange Trade Fund) that tracks the NASDAQ. The standard options are listed with black lettering showing the month, year, and the number of calendar days, in parentheses, remaining for trading. The Quarterly options are in red print with the word "Quarterlys" spelled out in the parentheses.

Figure 1

The most recent Quarterly option through 11-19-08 is the DEC5. Understandably, those options shall stop trading on the last trading day of December. The number five, following the specification of the month, stands for the fifth week of that month, which differentiates the Quarterly options from the customary options which stop trading at the end of the third Friday of the month. Unlike the regular options, the Quarterlies, as they should be grammatically spelled out, stop trading at the last trading day of the month, regardless if it is Friday or not. Furthermore, the option chain in Figure 1 also shows all subsequent quarterlies for the next year, 2009, which are also tradable as of now.

However, if we dig deeper into the Quarterlies, and observe the spread between the Bid and Ask, as well as the liquidity, we could conclude that similar to the Weeklies, the Quarterlies aren’t the wisest trading choice for option traders. The Quarterly options are lacking majorly in liquidity and they need some lubrication so they stop squeaking.

Figure 2 compares the Quarterly options on the QQQQ, the second most liquid ETF in the World, to its regular options in Figure 3. A brief review of the options basics, the gray horizontal line on Figure 2 and 3 identifies several columns. From left to right they are: Open Interest, Volume (for the individual strike price), Delta, Theoretical Price (which we’ll shorten to Theo. Price in our discussion), Bid, Ask, Expiration, and Strike Price. It is the Theo. Price that any option trader should be focusing on, for it is off the Theo. Price that the market makers create the Bid and Ask. Moreover, it is the Theo. Price often referred to as the Mid-Price that a retail option trader should always aim to obtain.

Figure 2

Observe in Figure 2 that the QQQQ have closed at 26.86 on 11-19-08 making the 25call strike price into the ITM (in the money), the 26call into the ATM (at the money), and the 27call into the OTM (out of the money). The pricing of the 25call is 18 cents wide, Bid is 3.46 and Ask is 3.64. Had we purchased a 25call at the Ask and instantly attempted to sell it at the Bid, we would lose 18 cents plus the cost of two commissions. The 18 cents spread on the Quarterlies is a chief challenge to overcome. Correspondingly, the 26call has the spread of 13, and the 27call has a 14 cents spread. All three calls (25call ITM, 26 ATM, and 27 OTM) have two digit spreads.

Now, let us scrutinize the Bid and Ask spread on the regular December option without focusing on the December premium being inexpensive when compared to the DEC5 or Quarterly.

Figure 3

Figure 3 shows that the 25call for December has the spread of 8 cents, Bid being 3.27, and Ask 3.35. An additional point of comparison should be the liquidity of individual strike prices which is self-evident from the Open Interest on either option chain. The chart below has extracted the Open Interest for the 25, 26, and 27call of DEC5 as well as for the standard December options.

Keep in mind that the QQQQ are the one of the most traded ETFs globally, and if the liquidity is not there on the QQQQ’s Quarterlies then in all other products, the open interest would be even less present.

In conclusion, taking into account the large spread between the Bid and Ask, and lack of liquidity on the Quarterly options, there is virtually no advantage in trading them over the standard options as a buyer. I personally use the Quarterlies only as a seller due to their "juicy premium." Although the Quarterly options aren’t traded only by the CBOE (Chicago Board Option Exchange), they are only slightly better than the Weeklies; the completion of the exchanges is there but the liquidity isn’t. The Quarterlies are squeaking like the wheel that needs some lubrication.

As an afterword, I wish to share with the Online Trading Academy community that I had gotten an email from a European trader who has informed me that the AEX index in Amsterdam also trades the Weeklies. Yet unlike the Weeklies in the USA, over there they are so popular that the Dutch market makers have also introduced the Dailies (Daily Options which stop trading at the end of each trading session). Moreover, the spread between the Bid and Ask on the Dutch weekly options are never more than 0.25 and liquidity isn’t an issue because at any given time there are ten Dutch market makers competing for the weekly orders on the AEX. Self-evidently, our exchanges still have a ways to evolve.

- Josip Causic

jcausic@tradingacademy.com