Question about meme/penny stocks…

[Fru-Gal]

Are penny stocks vulnerable to manipulation and/or more popular among retail traders because you can easily accumulate hundreds of shares, thus enabling options trading?

[secondcor521]

Hmm.

First, penny stocks and meme stocks are two different things.

Penny stocks are stocks priced in the pennies and therefore not traded on a typical exchange like the NYSE and NASDAQ and others.  This is because the main exchanges have minimum requirements for price per share, volume, market cap, and things along those lines.  Penny stocks are prone to manipulation because they are thinly traded, which means their price is subject to manipulation - if you can get a small but achievable number of people to buy into a thinly traded issue, the price will shoot up temporarily.  If you're good at your manipulation, you can "pump and dump" - get people excited about a stock, people start buying in, the stock price goes up, you can say "hey, see, it's going up just like I said", causing more to buy in and more price appreciation.  If you time it well, you can sell into the rally and get out of the stock before it crashes from people realizing they bought shares of a company that aren't worth what they paid.

Meme stocks, at least the ones I know of like GME and AMC (there are others), are not penny stocks.  But there is a similarity where a few people thought they could force a short squeeze and get similar behavior.  I think the difference is that the people hawking meme stocks at least genuinely believed that the company was worth more, whereas the penny stock pump-and-dump crowd were just opportunistic con men.  The line can be blurry sometimes, though.

Options trading probably exists on any stock on the exchange that has a sizeable enough market, which is probably most if not all of them.  But options really shouldn't create additional opportunities for manipulation AFAIK.  I would think they would add to price stability of the stock (although I can imagine the options themselves going haywire in price).  But I'm not very well versed in options so perhaps someone else with more experience on them can comment.

[Fru-Gal]

Thanks for that explanation.

I thought due to inflation penny stocks were anything under $20 a share? But I just looked it up and the current definition is under $5/share.

I own a few in that category. Have had some major winners that are now worth triple digits/share. Sadly since I only own a handful of shares have never made it big.

Perhaps using the term “meme” obscures my question, which is simply, do low-priced stocks appeal to retail traders for options trading because it’s easy to buy 100 shares?

BTW I own a few meme stocks as well. Most were in the $3-$20 category when I got in. No big winners, missed the peak/bought too late.

I also own WKHS, what a dog. It’s been trading under a dollar a share for months now (I read somewhere that it risks being de-listed). Seems they can’t even deliver 30 electric trucks to USPS.

[secondcor521]

I'm not sure there's a specific definition for penny stocks.  The $5 a share number you see may be a reference to the listing requirements for the major exchanges.  I think they have to have at least X shares and a share price of $5 a share or more, thus a market cap of a certain size.

You'll occasionally see a company do a reverse stock split for this reason.  If they trade below $5 a share and have enough shares, they can do a reverse stock split and get above the $5 a share number and thus stay listed (and have better access to capital).

Back when stocks were mostly sold in 100-share lots, there was sort of a cachet of having a higher stock price.  If IBM is trading at $90 a share, then that round lot history meant that an investor needed $9K to buy a round 100-share lot.  Kept the riff raff out that way.  Nowadays, with fractional shares and online everything, that's no longer the case, but I think the idea stays around because of momentum.

As to your question about low-priced stocks appealing for options trading because it's easier to buy 100 shares, I don't think that's the right way to think about it.  Yes, options are quoted and traded in 100 share blocks.  But the price of an option is influenced more by the volatility of the stock, the strike price of the option, and the expiration date more than the underlying stock price.  That's because the option is exactly that - you're paying (or getting) money in order to buy (or sell) the option to buy (or sell) a stock.

As a random example, the May 24th call option on P&G at a strike price of $175 is trading for 3 cents an option; the shares themselves closed at $167.86.  A single option contract would therefore cost $3 and give you the option (but not the obligation) to buy 100 shares of P&G stock for $175 any time between now and next Friday.  Since you can buy P&G stock directly on the market tomorrow for somewhere in the high $160s (probably), you can see that it's not worth that much to have the option to pay more for it for the next week or so.  The option only has value if P&G somehow manages to trade above $175 in the next 8 days.  Which, being a very boring and non-volatile stock, it probably won't.  So you'd pay $3 for probably no good at all.

But let's say it did go up to $180 next Thursday and you choose to exercise the option.  That doesn't mean you just get 100 shares of P&G stock for the $3 you paid.  You just bought the option to buy the stock.  You still have to fork over the $17,500 ($175 x 100) for the shares themselves.  You could turn around and sell them on the market for $18,000 ($180 x 100) and pocket $500 in profit, minus the $3 you paid for the option, minus short term capital gains of maybe $100 on your stock profit.

Since those options are priced at $3 and the possible profit is $500 - $3 - $100 = $397, I'm willing to bet you that P&G doesn't go above $180 before next Friday.  And if it gets closer, the price to buy those call options will go up accordingly.

There are two flavors of options - call options, which are the option to buy, and put options, which are the option to sell.  Based on those two flavors, you can build all sorts of complicated option constructions (spreads, straddles, butterflies? etc.).  At the end of the day, all options are just bets on the future direction of the price of the underlying asset.

HTH.

[Fru-Gal]

Oh! I realize I was thinking about a specific type of option, namely selling covered calls. In order to do that, you have to own 100 shares since they are sold in 100 share blocks.

I forgot that you could buy or sell options on stocks you don’t own. Not something I plan on doing, but am interested in selling covered calls of VTI per the book shared on this forum. Need to read it again and do paper trades first.

[MustacheAndaHalf]

Perhaps using the term “meme” obscures my question, which is simply, do low-priced stocks appeal to retail traders for options trading because it’s easy to buy 100 shares?

I think retail traders were trained in a bull market where everything recovers, which influences how they speculate.  If a stock goes down, they expect it to recover.

During Covid I invested in dozens of beaten up stocks, expecting that even if half went bankrupt I'd still profit off the rest recovering.  One of those purchases was Hertz, which I bought after Covid knocked the stock to new lows.  Hertz declared bankruptcy, which sent it even lower.  A day or two after declaring bankruptcy... the stock moved up!  It appears retail traders figured it was a deal, and bought the stock.  I sold after that surge, losing a smaller percentage as a result.  But those retail traders were ignorant of how little investors get paid in bankruptcy - getting wiped out is very common, since bond holders get paid back in full, first.

That anecdote isn't as good as a study of retail investor motivations, but it shows me that even a bankrupt stock won't stop retail investors from buying it.

[secondcor521]

Oh! I realize I was thinking about a specific type of option, namely selling covered calls. In order to do that, you have to own 100 shares since they are sold in 100 share blocks.

I forgot that you could buy or sell options on stocks you don’t own. Not something I plan on doing, but am interested in selling covered calls of VTI per the book shared on this forum. Need to read it again and do paper trades first.

Ah, yeah, you left that part out. ;-)

So selling a call is accepting money from someone to give them the right to buy 100 shares of whatever at a specified price in a specified timeframe.  In your case, VTI.

Options *can* expire worthless.  If you sell a call option on VTI at a strike price of $285 for June 21st, you can collect $1 for that option (the call option is trading at 1 cent).  If VTI never trades above $285 between now and then, then the person who paid you $1 for that option will just never exercise it.  You keep the $1, and it apparently doesn't matter if you owned the 100 shares of VTI or not.

But if they do exercise the option, then somehow someone has to deliver 100 shares to them for $28,500.  If you're selling the option and own those 100 shares VTI, then that is having the stock called away from you.  That's a risk you're taking by selling those covered calls, because you're giving away (well, selling) any upside over $285 between now and June 21st.  You end up selling the shares to the person who bought the call option for $285, but those shares might be worth $287 on the open market.  It does happen from time to time, and it's the main risk to the strategy you're considering.

If you don't own the underlying shares, then I think that's called naked selling, and you may need to get approved for a margin account to do that.  Because worst case, if the call option you sell gets exercised, you have to buy the shares on the open market, maybe for $287 a share, then deliver them to the option buyer at $285 a share, and you're $200 in the hole (i.e., in debt to your broker) that you have to cover somehow.  Your broker wants to know that you'll pay them back!

Another choice is if the option you sell might get exercised (because VTI is getting close to $285 a share in this example), then you can buy it back.  But the price you pay to do that might be more than the price you sold it for earlier.  Then you're off the hook to deliver the 100 shares VTI, but you lost money in the process.

Oh, and options, like any other financial instrument, have trading costs.  Bid / ask spreads and commissions are at least two things that I think create trading costs for options, just like they do for stocks.

It's a zillion times more complicated than that, and since I don't trade options I'm not 100% sure of the above.  Maybe someone who trades options will correct / clarify / amplify.

Personally I think betting on the future prices of stock is very difficult, so I don't even try.  But some folks here do.

[bacchi]

Looks correct to me. ^^

I will caution that going naked short on a high volatility stock, like GME, is a dangerous game. Some brokers, like Interactive, can and will adjust the margin requirements mid-month, forcing you to quickly close a position, often at a loss, or wire some money.

Selling covered calls really only works when the market is in the doldrums. Otherwise, like secondcor521 mentioned, you risk losing out on gains. For example, the VTI June 21 265C has a price of $2.56 at $265. There's a pretty decent chance that VTI will be greater than $267.56 in a month considering it's only 2.2% gain.

[secondcor521]

Looks correct to me. ^^

I will caution that going naked short on a high volatility stock, like GME, is a dangerous game. Some brokers, like Interactive, can and will adjust the margin requirements mid-month, forcing you to quickly close a position, often at a loss, or wire some money.

Selling covered calls really only works when the market is in the doldrums. Otherwise, like secondcor521 mentioned, you risk losing out on gains. For example, the VTI June 21 265C has a price of $2.56 at $265. There's a pretty decent chance that VTI will be greater than $267.56 in a month considering it's only 2.2% gain.

Thanks for the confirmation.

I would guess if the market is in the doldrums, the options prices in general are lower, right?

Of course, the market can change it's mood from time to time.  The "pretty decent chance" VTI goes up 2.2% in a month would not seem as high a year or so ago when the market was dropping the whole year.

[bacchi]

Looks correct to me. ^^

I will caution that going naked short on a high volatility stock, like GME, is a dangerous game. Some brokers, like Interactive, can and will adjust the margin requirements mid-month, forcing you to quickly close a position, often at a loss, or wire some money.

Selling covered calls really only works when the market is in the doldrums. Otherwise, like secondcor521 mentioned, you risk losing out on gains. For example, the VTI June 21 265C has a price of $2.56 at $265. There's a pretty decent chance that VTI will be greater than $267.56 in a month considering it's only 2.2% gain.

Thanks for the confirmation.

I would guess if the market is in the doldrums, the options prices in general are lower, right?

Of course, the market can change it's mood from time to time.  The "pretty decent chance" VTI goes up 2.2% in a month would not seem as high a year or so ago when the market was dropping the whole year.

Good point.

The best time to sell covered calls, then, might be when the market is generally declining and one doesn't need to otherwise sell the underlying shares.

There are some buy-write ETFs out there. QYLD sells against the QQQs and it's been hammered for over 10 years even with the high yield. Same with JEPI, which writes against some (131) of the S&P 500 holdings.

It's a strategy that has a time and place.

[Financial.Velociraptor]

@Fru-Gal

"penny stocks" as well as "meme-stocks" (two somewhat overlapping circles to that Venn Diagram) tend to have higher volatility than blue chips and diversified funds.  As a result, a covered call or cash secured put (or even "naked" put) will tend to have higher premiums paid as a percentage of the underlying price on a penny or meme stock.  That is sort of shiny and fires up the greed of neophyte options traders.  The market is not perfectly efficient for options (my opinion only) but it is substantially efficient.  That extra premium, would be discussed in a graduate level finance class as a "risk premium".  You are being paid extra because you are more likely to get shaken out or be left holding toxic waste that falls more than the premium you were paid.

As far as writing covered calls on broad indexes (as per the book with the super cool wizard stickers) the diversified nature mathematically lowers the "beta" and thus suppresses premiums.  If you can afford to own 100 shares each of the top 10 holdings of an etf/index and write CC against all ten individually, you would expect to earn more premium that writing CC on the actual index! 

Writing CC on say Gamestop (GME) is very risky because while you keep the premium whether stock goes up or down, you are holding something that is probably destined to eventually be worth $0.00/share. 

I'll also note that a stock with a nominal price under $5/share is much less likely to have options available to trade and that if it does, the liquidity tends to really stink resulting in wide bid/ask spreads.  Count on either not having your bid fill often, or getting scalped by the market maker when you overbid (ok, under-ask) to make trade clear market.  You get less premium on SPY/VOO than the average of CC on the top ten holdings but you get much better liquidity, quick execution, and single penny bid/ask spreads on the index/etf.

[WayDownSouth]

I'm not sure there's a specific definition for penny stocks.  The $5 a share number you see may be a reference to the listing requirements for the major exchanges.  I think they have to have at least X shares and a share price of $5 a share or more, thus a market cap of a certain size.

You'll occasionally see a company do a reverse stock split for this reason.  If they trade below $5 a share and have enough shares, they can do a reverse stock split and get above the $5 a share number and thus stay listed (and have better access to capital).

Back when stocks were mostly sold in 100-share lots, there was sort of a cachet of having a higher stock price.  If IBM is trading at $90 a share, then that round lot history meant that an investor needed $9K to buy a round 100-share lot.  Kept the riff raff out that way.  Nowadays, with fractional shares and online everything, that's no longer the case, but I think the idea stays around because of momentum.

As to your question about low-priced stocks appealing for options trading because it's easier to buy 100 shares, I don't think that's the right way to think about it.  Yes, options are quoted and traded in 100 share blocks.  But the price of an option is influenced more by the volatility of the stock, the strike price of the option, and the expiration date more than the underlying stock price.  That's because the option is exactly that - you're paying (or getting) money in order to buy (or sell) the option to buy (or sell) a stock.

As a random example, the May 24th call option on P&G at a strike price of $175 is trading for 3 cents an option; the shares themselves closed at $167.86.  A single option contract would therefore cost $3 and give you the option (but not the obligation) to buy 100 shares of P&G stock for $175 any time between now and next Friday.  Since you can buy P&G stock directly on the market tomorrow for somewhere in the high $160s (probably), you can see that it's not worth that much to have the option to pay more for it for the next week or so.  The option only has value if P&G somehow manages to trade above $175 in the next 8 days.  Which, being a very boring and non-volatile stock, it probably won't.  So you'd pay $3 for probably no good at all.

But let's say it did go up to $180 next Thursday and you choose to exercise the option.  That doesn't mean you just get 100 shares of P&G stock for the $3 you paid.  You just bought the option to buy the stock.  You still have to fork over the $17,500 ($175 x 100) for the shares themselves.  You could turn around and sell them on the market for $18,000 ($180 x 100) and pocket $500 in profit, minus the $3 you paid for the option, minus short term capital gains of maybe $100 on your stock profit.

Since those options are priced at $3 and the possible profit is $500 - $3 - $100 = $397, I'm willing to bet you that P&G doesn't go above $180 before next Friday.  And if it gets closer, the price to buy those call options will go up accordingly.

There are two flavors of options - call options, which are the option to buy, and put options, which are the option to sell.  Based on those two flavors, you can build all sorts of complicated option constructions (spreads, straddles, butterflies? etc.).  At the end of the day, all options are just bets on the future direction of the price of the underlying asset.

HTH.

Experienced day trader here. What I refer to (just for clarification) as "penny stocks" when I play is anything from $0.15 to about $5. This is the highly lucrative area for me and my trading style which is basically a very unique form of sniping.

I can tell you with zero doubt that not only are these stocks vulnerable to manipulation by the company itself, but moreso buy the massive brokers. If you're familiar with what Level II is and how to watch and read it properly, you can see outright manipulation happen right in front of your eyes. There are laws and regulations that most don't even know exist which allow brokers to "lend" shares to each other without making an actual trade, giving them extreme leverage without needing to pass the clearing house. They use high powered computers and various algorithms to seek and manipulate anything and everything they can, especially the movers on any given day.

Many many day traders have proof of this, it's not a secret, it's just a part of the game you cannot avoid and must deal with. SEC knows it, does nothing about it, doesn't care because these guys have the SEC in their bankroll.

As far as pink sheets go, you can make a killing but they're a lot shadier than regular trades. I do not think that most people understand just how bad the market manipulation is and how deep it goes at all levels. However, I only have firsthand experience with it at the level that I defined in this post as penny stocks, and with pink sheeters.

Actually I did witness the same with AMC and Gamestop during the "great takeover" when the investment firms lost untold billions and recovered sizeable portions very quickly via OBVIOUS manipulation. SEC did nothing even though the who MEME-STOCK world had the evidence.

Play with caution.