I rarely, if ever, discuss options in the Small Cap Investor
However, the number of questions from readers has recently
picked up regarding this fast growing investment approach. And I
have research analyst Andy Crowder on our team - he has over a
decade of experience trading options and publishing his strategies
for a select group of subscribers.
So I've decided to set some time aside to discuss options and
how to use them appropriately with small cap stocks. Hopefully this
will help you begin to understand that options offer endless
possibilities to increase your returns in an up, down or
***The easiest way to search for companies that have optionable
stocks is to screen for them using a stock screener like
This is extremely easy and only requires 4 simple steps.
Click on the 'All' tab
Set Market Cap to "Small (under $2 billion)
Set Average Volume to "Over $1M"
Set Option/Short to "Optionable"
Click the image to enlarge
Once you complete the aforementioned steps you should come up
with roughly 313 companies that meet our requirements.
This first screen is a necessary part of the process when
trading options on small cap stocks. That's because most small cap
stocks are not optionable, meaning options are not available on the
stock. If the stock is optionable it may still lack the volume
necessary to make a sound and reasonable option investment.
Most importantly, this screen will save you lots and lots of
I suggest saving this screen for future reference so you can go
back and check your list to see if your next small cap stock of
choice is optionable. Thank me later, as this is a true time saver.
***The most important search criteria for finding what I call
'tradeable' options on small cap stocks -
. The reason I chose to search for small cap stocks with an average
volume over 1 million shares traded is because I want liquid
options. Liquidity directly translates into a reasonable bid/ask
spread for options -
this is critical
The more liquid the option the tighter the bid/ask spread. This
is extremely important because the bid/ask spread impacts the cost
of using options. Wide bid/ask spreads eat into the potential
profitability of your investment, and contribute to what is known
A real world example of how volume effects the bid/ask spread
should help to clarify.
The Cheesecake Factory (Nasdaq: CAKE)
USANA Health Sciences (Nasdaq: USNA)
for our exampIe. I chose these two companies because they are both
small cap stocks with share prices of roughly $30 a share. I want
to choose two stocks with equal properties, other than volume. The
impact of volume will be blatantly obvious on the bid/ask spread.
If you look at the June 30 calls for both stocks you will see
the following bid/ask spread:
|The Cheesecake Factory (Nasdaq: CAKE)
|USANA Health Sciences (Nasdaq: USNA)
Notice the difference?
The bid/ask spread is $.10 on CAKE compared to an enormous $0.50
This is the reason why a tight bid/ask spread is so critical
when using options as part of your investment strategy. You can
rarely buy an options contract at anything other than the ask
price, and you can rarely sell one at anything other than the bid,
especially if the options are illiquid. It is you versus the market
maker and believe me you will never win that battle. With a wide
bid/ask spread you are technically underwater 10 to 30 percent or
more, right from the get go. Nobody wants to make up 30 percent
just to breakeven.
In conclusion, dealing with the bid/ask spread is an inevitable
part of the options arena. Focus on more liquid and actively traded
contracts that have smaller bid/ask spreads, rather than stocks
with little to no volume and wide spreads. This is an important
lesson to learn when using options as part of your investment
strategy. You will save yourself many headaches and most
importantly, hard-earned money.
As stated earlier, I will be back in the coming weeks with more
to discuss on the wonderful world of options.