Commissions

As we have seen, the same brokerage system that trades stocks can execute options transactions. In stocks, commission charges depend on the number of shares and the dollar value of the transaction. A similar system applies for call options contracts. The following schedule shows a representative commission schedule from a discount broker. Full-service brokerage fees can be substantially higher.12 In addition to these fees, each transaction can be subject to certain minimum and maximum fees. For instance, a broker might have a maximum fee per contract of $40.

Representative Discount Brokerage Commissions

Dollar Value of Transaction

Commission

$0-2,500

$29 + 1.6% of principal amount

$2,500-10,000

$49 + 0.8% of principal amount

$10,000 +

$99 + 0.3% of principal amount

As an example of commissions with this fee schedule, assume that you buy five contracts with a quoted price of $6.50. The cost of the option would be $650 per contract, for a total cost of $3,250. The commission would be: $49 + .008 X $3,250 = $75. For the same dollar value of a transaction in stocks, the commission tends to be lower. However, once the dollar amount of the transaction approaches $10,000, commissions on stocks and options tend to be similar.

Even though the commission per dollar of options traded may be higher than for stocks, there can be significant commission savings in trading options. In our example, the option price is $6.50 per share of stock. The share price might well be $ 100 or more. If it were $ 100, trading 500 shares would involve a transaction value of $50,000. Commissions on a stock transaction of $50,000 would be much higher than commissions on our option transaction. Trading the option on a stock and trading the stock itself can give positions with very similar price actions. Therefore, options trading can provide commission savings over stock trading. This principle holds, even though options commissions tend to be higher than stock commissions for a given dollar transaction.

Another way to see this principle is to realize that options inherently have more leverage than a share of stock. As an example, assume the stock price is $100 and the option on the stock trades for $6.50. If the stock price rises 3 percent to $103, the option price could easily rise 30 percent to $8.45. On a percentage basis, the option price moves more than the stock price. Unfortunately for option traders, this happens for price increases and decreases. With this greater leverage, the same dollar investment in an option will give a greater dollar price movement than investment in the stock.

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