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.
Key Takeaways
- 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 Cboe Exchange (Cboe) rules, there are five criteria that a stock must meet before it can have options as of April 2022.
- The underlying equity security must be a properly registered National Market System (NMS) stock.
- The company must have at least 7 million publicly held shares.
- The underlying stock must have at least 2,000 shareholders.
- Trading volume must equal or exceed 2.4 million 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. However, meeting all of the criteria doesn't guarantee acceptance.
A company cannot have options traded on its stock until at least three business days after its initial public offering (IPO) date.
Price Requirements
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 February 2024, 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 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 about 445 million; that volume grew to more than 1.3 billion contracts in 2005.
The Options Clearing Corporation is the world's largest derivatives clearinghouse and reported clearing 11.1 billion contracts in 2023. Investors have discovered the huge cost efficiency in using the leveraging power of options to increase their potential returns and hedge their risks.
Personal Risk Requirements
Many options listed on exchanges might not meet your risk requirements. As derivatives, they can sometimes be more dangerous than their underlying securities. However, options can also be used to reduce risk as well. 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.
How Many Shares Do You Need for Options?
For a stock to have options, it must have 7 million publicly available shares. In terms of an options contract, one contract is typically for 100 shares.
How Does a Stock Become Optionable?
Becoming optionable is not automatic for a stock. The exchange decides when and whether to list a security for options trading; typically, the security must meet the exchange's criteria, but the exchange still reserves the right to approve a stock that doesn't meet those criteria or to deny one that does.
What Determines Whether a Stock Is Optionable?
For a stock to be optionable, it must meet the requirements of the exchange. For Cboe, the security must be a registered NMS stock with at least 7 million publicly held shares and 2,000 shareholders. Additionally, trading volume must meet or exceed 2.4 million shares in the past 12 months, and share prices must meet minimum requirements according to security type.
The Bottom Line
Stocks must meet a stringent list of requirements to be optionable, and not every stock will qualify. Stocks must meet exchange regulations in order to be listed with options; the exchange has the final word, not the stock-issuing company. Although the regulations are designed to protect investors, you should still do your due diligence before trading options on any security.
