While USO may not actually rendezvous with zero, it’s certainly getting close enough for option traders like myself to petition the market gods for a split. Its ultra-low price tag is starting to annoy me. It should be bugging you too. You see, option trades are hard to structure on cheapskate securities in the dollar holler club (my totally made up name for stocks in the single digits). Yes, I know USO isn’t yet sub-$10 but it’s so close I gave it honorary membership.

So what’s the problem? Well, have you ever tried to structure a spread trade on a cheap stock? It can be done but it’s expensive, not to mention terribly inefficient. In this case I don’t mean expensive from a capital outlay perspective, I mean expensive as in commission costs relative to potential profit. Ideally, the commission required for a trade sits no more than about 10% of the potential profit. If I enter a trade with the ability to generate $100 in profits, I don’t want to have to pay more than around $10. Might you be okay with a bit higher commission cost like 15% or 20% of potential profit? Sure. But for heaven’s sake, man, don’t sabotage the trade from the get-go with burdensome costs.

Obviously, the lower the better.

Case in point. With USO perched at $11 I can sell a one month 10/8 bull put spread for 27 cents credit. If I’m paying $1.50 a contract, that’s $3 total to enter. Even if I end up letting the spread expire worthless that $3 represents 11% of the potential profit. If you’re like most traders and try to exit early by snatching back the spread for, say, 5 cents, now you’ve really blown your costs out of the water. You made 22 cents but had to pay $6 for the trade. That’s 27% of the profit.

Lame.

In contrast, on a $50 stock I should be able to sell a $5 bull put spread for around 60 cents credit. The $3 to enter only represents 5% of the potential profit. Even if I pay another $3 to exit at 5 cents, I’m still limiting the cost to around 10% of profit. That’s a far cry better than 27%, no?

But wait, Tyler, why not just sell naked puts?

You could, but I don’t like being relegated to only selling naked options because it makes no economic sense to do a spread. And even with naked options it’s going to get to the point where short-term out-of-the-money options for USO are trading for pennies. So how to fix it?

Split the ETF, son!

No, not that kind of split. A reverse split. Never seen one of those? Count yourself lucky. It’s an event known only to sucky stocks. Jack the price of USO fourfold to around $40 and reduce the shares outstanding by four, a so-called 1-for-4 split. Or better yet, lift the price to $100 (1-for-10). I don’t care. Just solve the problem.

Once the price is higher we’ll have that much more juice in the OTM options, not to mention all the additional OTM strikes that actually have some premium in them to choose from when structure trades.

Want a successful example of this happening? Check out the iPath S&P 500 VIX Short-term Futures ETN (VXX).

The reverse split solution has been implemented three times in VXX. The volatility ETN is yet another popular product whose suckitude necessitated a number of resurrections to extend its shelf life. VXX burst onto the volatility scene in January 2009 at a cool $100. Then, the plunge began and it hasn’t stopped since. The first time VXX reverse split (1-for-4) its price chart was adjusted so that it looked like the fund started trading at $400. The next time if reverse split (1-for-4, again) the initial price lifted to $1600. The third and final time (so far at least) it was adjusted to $6400.

Now you know why VXX’s chart looks like a falling safe. $6400 to $19, Wow! VXX, you suck. Were it not for some reverse split magic you would have done been dead years ago.

And the upside down banana split? How else are you supposed to convey the idea of a reverse split?

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