Optionable stock refers to a class of equity that possesses sufficient liquidity and market interest such that a market maker, typically a financial institution like a bank, creates and lists options contracts based on that stock for trading. These options allow traders to speculate on the future price movement of the underlying stock or hedge their current positions.
Definition
An optionable stock is a stock on which options (derivatives) can be traded, given the stock meets specific criteria of liquidity and market demand. These options include calls and puts, which give the buyer the right, but not the obligation, to buy or sell the stock at a predetermined price before the option’s expiration date.
Mechanism
Options on stocks work through a contract between buyers and sellers. The buyer of an option pays a premium for the right to either purchase (call option) or sell (put option) the underlying stock at a set strike price within a specified period. The seller, or writer, of the option earns this premium and must fulfill the contract if the option is exercised.
Call Options
Call options give the holder the right to buy the underlying stock at a specific strike price before the expiration date.
Put Options
Put options give the holder the right to sell the underlying stock at a specific strike price before the expiration date.
Requirements for a Stock to be Optionable
For a stock to be classified as optionable, it generally needs to meet several criteria set by the options exchange:
- Liquidity: The stock must have sufficient trading volume to ensure that options can be traded efficiently.
- Price Stability: The stock should maintain price stability suitable for the options market.
- Market Capitalization: A sufficiently high market cap is often required to ensure investor interest and trading volume.
- Exchange Listing: The stock must be listed on a recognized exchange that supports options trading.
Examples
- Apple Inc. (AAPL): A highly liquid stock with extensive options available for trading.
- Tesla Inc. (TSLA): Known for its active options market due to high volatility and trading volume.
Historical Context
The concept of optionable stocks gained prominence with the establishment of options exchanges such as the Chicago Board Options Exchange (CBOE) in 1973. Initially, a select group of stocks were deemed optionable; over time, the number of optionable stocks has expanded significantly.
Applicability
Optionable stocks are critical for investors employing diverse strategies, such as hedging, speculation, income generation through premiums, and leveraging positions.
Comparisons
Optionable vs. Non-Optionable Stocks
- Optionable Stocks: Allow trading of derivative options.
- Non-Optionable Stocks: Do not have an associated options market.
Optionable Stocks vs. Other Securities
- Options on ETFs: Some ETFs are also optionable, providing a diverse array of underlying assets.
- Futures Contracts: Unlike options, futures obligate the holder to buy or sell the underlying asset at expiration.
Related Terms
- Derivative: A financial security whose value is dependent on an underlying asset.
- Strike Price: The predetermined price at which the underlying stock can be bought or sold.
- Premium: The price paid for purchasing an option.
- Expiration Date: The date on which the option contract expires.
FAQs
What makes a stock optionable?
Can all stocks have options?
What are the benefits of trading optionable stocks?
References
- Chicago Board Options Exchange (CBOE). “Options on Stocks.” CBOE.
- Hull, John C. “Options, Futures, and Other Derivatives.” Prentice Hall.
Summary
An optionable stock is a type of equity that meets certain liquidity and market interest criteria, making it eligible for options trading. This designation allows traders to engage in sophisticated financial strategies, contributing to market efficiency and liquidity.
