Question

This question was posted in October of 2007, but the answer still applies to future option listings. The QID is a huge product (ETF of double short NASDAQ). I would think it would have a large speculative appeal as a listed index option. Is there some rule or reason there are no options listed for this product?

Answer

The demand for a particular determines if options will listed. The Market Makers/Specialists that commit time and resources to maintaining an orderly market need to know that all of their expenses will be justified. They make money by buying bids, selling offers and hedging risk through futures or the underlying basket of stocks. If the liquidity is not there, they will lose money because of their upfront and ongoing expenses. Most of there function is currently done by auto-quote and the positions are electronically hedged in seconds. There aren’t the man-hours like there used to be, but there are still costs.

In this instance, traders have many alternatives to achieve an equivalent QID position in existing, liquid markets. Instead of going long a QID, they calculate the coresponding ratio and they short in the NDQ futures or QQQQ. The options in those products are also very active and the bid/ask is tight. There is no advantage to trading QID except for IRA accounts where you can only go long. Most IRA accounts will let you buy puts anyway. There are so many ETFs being listed that someday there will be more ETFs than stocks, just as there are more mutual funds than stocks.

As soon as you get off “the beaten path”, option bid/ask spreads widen out. When there is an equivalent way to structure a trade using liquid markets, that will always be your best option. Greater liquidity means there are more people to take the other side of your trade and you are not at the mercy of a Market Maker who won’t budge on a wide bid/ask.

When it comes to liquidity can be an issue. However, every company is different and in many instances, I can justify taking a position even if the option bid/ask spreads are wide. In these cases, it has to be a long-term trade using at least 4-month options. I do not want to navigate that bid/ask more than twice – once on the entry and once on the exit.

Thank you for the question.

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