Micro-Sized Stock Options Are a Clear Sign It’s Time to De-Risk

(Bloomberg Opinion) -- The Chicago Board Options Exchange plans to launch “nano” options on the S&P 500 Index early in 2022. These contracts will be one-hundredth the size of the mini S&P 500 options and one-thousandth the size of the options commonly used by institutional investors such as hedge funds. As Bloomberg News points out, this means that if an option on the S&P 500 is priced at $1,000, the corresponding nano option would cost $1. The nano options will have a maximum maturity of one week and be settled in cash.

There are a few things to unpack here, and not all of them are good. On one hand, Cboe Global Markets Inc. is trying to get small -- very, very small -- retail investors to spend a few dollars on an option contract here and there, in the hopes that these small investors will one day become large investors and trade the institutional size contracts. This won’t be profitable for the exchange anytime soon; it’s an investment in the future, much as fractional shares are for the retail brokerages. You want to get ‘em hooked while they’re young.

The other thing is that SPY options—options on the SPDR S&P 500 ETF Trust—have been more popular with retail traders, and the CBOE is in direct competition with other exchanges for that business. Of course, SPY options are too large for some people to buy even a single contract. Also, physical settlement seems a bit easier to understand for retail investors. 

This is just the latest effort by a derivatives exchanges to retail-ize their products. It started in 1997, when the Chicago Mercantile Exchange listed e-mini futures to trade alongside the larger, pit-traded contract, at one-fifth the size. The e-minis took a while to catch on, but they did succeed in creating a brisk arbitrage between the two products. The pit-traded contracts were finally delisted last year, and only the e-minis remain. But the CME recently listed micro S&P 500 futures, which are one-tenth the size of the e-minis. It’s hard to say whether they’ve picked up any traction with retail investors, but again, there is the opportunity for arbitrage.

If you were around in the 1990s, it may have been hard to imagine at the time that exchanges would ever encourage futures and options trading among the public. There’s nothing inherently complex about futures—they’re linear instruments—but investors often get in trouble with the margin. Then again, nano options are just part of a long progression toward the normalization of gambling that began around the turn of the century. It’s notable that there is nothing in the CBOE literature about using nano options to hedge or manage risk.

I remember a time when the only two places you could gamble in the U.S. outside of state lotteries and bingo halls were Las Vegas and Atlantic City, New Jersey. And there was a great-deal of hand-wringing when the Native American casinos appeared on the scene and exploded across the country. They were followed in turn by non-Native American casinos, which you will occasionally find in strip malls next to grocery stores.

Daily fantasy sports appeared in the 2010s as a nifty way to get around sports gambling laws. Now, sports gambling is all but legalized and the sports channels have television programs that do nothing but talk about odds making. Fantasy sports have persisted despite evidence that a small group of sophisticated players hoover up all the prize money, leaving little for everyone else. It is all about the action. Even the state lotteries have greatly expanded their offerings, with the Mega Millions and Powerball games virtually nationwide. Powerball even added a third weekly drawing recently. Scratch-off tickets are more common than they used to be, and there is a whole cottage industry online about how to “game” them.

I view the whole situation with some equanimity. There is nothing wrong with recreational risk-taking. But risk-taking among the public generally corresponds to peaks in sentiment. Nano options don’t portend the end of the world, and they are probably little more than a diversion for most punters, but it’s a sign of the times. When the world is taking more risk, you want to be taking less.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Jared Dillian is the editor and publisher of The Daily Dirtnap, investment strategist at Mauldin Economics, and the author of "Street Freak" and "All the Evil of This World." He may have a stake in the areas he writes about.

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