Options trading in the U.S. hit a milestone last month as the Chicago Board Options Exchange (Cboe) marked its 50th anniversary on April 26.
A lot has changed over the decades since that pioneering exchange introduced contracts to buy or sell 100 shares of stock at a fraction of the price of the underlying security.
Investors have developed scores of strategies to go long, short or neutral with contracts that span from as long as a couple of years to just a single day. You can design trades based on changes in volatility or time.
Don’t want to pay a lot for an option? Then choose a spread — buying and selling a pair of options in the same stock at different prices, as one example — and know your maximum potential profit and loss ahead of time.
Trading volume on options markets has soared since 1973, and especially in recent years. At least 16 exchanges handle options trades in the U.S. today.
Will Options Trading Evolve?
But will options trading keep up its torrid pace? It’s hard not to answer with a resounding yes.
For starters, new options marketplaces will debut later this year and next, including New York-based MEMX in August. New options products appear to be continually in the works. And ironically, rising market volatility may actually help the industry in the long run by driving home to investors the value of hedging strategies, where options play a big role.
No doubt, plenty of efforts are still needed to educate the public and promote continued growth. However, recent reports from investment app operators appear to affirm this is taking place.
Robinhood Markets (HOOD), which runs an app that’s highly popular among younger investors, reported last month that options contract volume rose 8% in February vs. the same month a year ago to 89.4 million contracts. In contrast, the company saw a 7% drop in cryptocurrency trading volume over the same period.
“I cannot see anything other than explosive growth” in options trading, Tom Sosnoff, co-founder of Tastytrade, told IBD. He’s CEO of options-focused brokerage and media company Tastylive Inc.
Steven Sears, president and chief operating officer of Chicago-based investment advisor Options Solutions, thinks the potential for industry growth goes well beyond a desire among traders to score big profits quickly.
“The over-focus on short-term trading is a reflection of the desire that so many people have to get rich as fast as they can. Such a mindset is not conducive to successful investing,” Sears told IBD via an email exchange. “America faces a massive retirement crisis, and we could help generations of people if Wall Street used just a little bit of its incredible resources to fund a nationwide investor education campaign that taught children, and adults, how to think about investing.”
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Options Trading: A Real Growth Industry
The options industry already has created thousands of jobs — 1,543 at the Cboe Global Markets (CBOE) alone, as of Dec. 31. Meanwhile, advanced technologies have created robust trading platforms for individual and pro investors. They can tap new paths to profits by piloting a squadron of strategies in options trading. Options traders can capitalize on opportunities within a variety of markets and across a range of market behavior — from the trending market, up or down, to the trendless one.
And how about the emergence in the past year of so-called 0DTE (zero days to expiration) options on equity indexes? These new products allow you to speculate on intraday stock market action by, say, buying or selling the S&P 500 short.
“I think the transition from passive investing to active investing is just starting,” said Sosnoff at Tastytrade, previously called Tastyworks, which ranked as the top broker overall in the IBD Best Online Brokers survey in 2021. (See our 2023 Best Online Brokers list.)
Short sellers may never forget the meme-stock boom of 2021, when followers of the WallStreetBets threads on Reddit joined forces by buying gobs of call options. Their banded efforts ultimately sent the shares of struggling companies such as GameStop (GME), AMC Entertainment (AMC) and BlackBerry (BB) skyrocketing in price for months. Their moves led to the demise of some hedge funds, including Melvin Capital.
Options Industry Challenges
Steve Sosnick, chief strategist at Interactive Brokers (IBKR), noted that the GameStop rally of 2021 exemplified the power of options traders against institutions.
“An imbalance of bettors makes the roulette wheel no more likely to end on red or black. But if enough traders buy call options in sufficient quantities, they can push markets in their desired direction,” Sosnick wrote in a February Barron’s column. “A wave of aggressive call buyers can force those who sold the options to hedge by buying the underlying stocks or ETFs. In the extreme, this can become a feedback loop of positive momentum, creating a microburst of volatility.”
But the options business faces competition from other trading products, including exchange traded funds. And financial advisors appear slow to incorporate options as a cornerstone strategy in client portfolios.
Financial advisors “are not strategists. They’re salespeople. I think that’s fair to say,” Sosnoff said. He served as a floor trader and seat member at Cboe before co-founding the Thinkorswim trading platform. Thinkorswim got sold to TD Ameritrade, which is now owned by Charles Schwab (SCHW), in January 2009 for $606 million.
“The FA’s (financial advisor’s) job is to raise assets under management and manage those assets. But that’s been the game plan for 50 years,” Sosnoff said. “In the future, good FAs will embrace all products. The job in trading is to improve cost basis for survival. With options you can do that. You buy something, then you sell something against it.”
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Options Trading Statistics
In 1973, with the Chicago Board Options Exchange as the sole hub for options trading, a total of 1,119,245 options contracts exchanged hands. According to Angela Tu, Cboe Global Markets media officer, dealers made 911 trades in 16 separate stocks on the first day. By year’s end, options trading took place in 32 issues.
By 1987, more than 500 equities saw options listed across four exchanges, including the American Stock Exchange and the Philadelphia and Pacific exchanges, with the latter formerly housed in downtown Los Angeles. Total options trading volume ballooned to 305.2 million contracts that year, up nearly 280-fold in the span of 14 years.
“As an exchange operator, you have to listen to every individual of different size and shape. That includes the sophisticated individual investor,” Edward Tilly, CEO of Cboe, told IBD. Tilly stressed that the exchange’s ongoing mission to offer open access, transparency and reliable marketplaces has helped boost growth.
Tilly credits the entire industry for pushing forward the technology and platforms that have allowed options traders to back-test ideas, conduct paper trading and customize strategies. “It’s also a constant cycle of refreshing the innovative and the new. But in the end, it’s about education, education, education,” Tilly said.
Tilly sees ample room for growth for expanding beyond product innovations like zero days to expiration (0DTE) options. “We operate in 26 regulated markets around the globe,” he said. “There’s demand for exposure to our markets around the clock.”
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Growth In Options Trading Volume
The pace of growth after global markets survived the much-feared millennium bug? Simply staggering. In 2000, the year that the International Securities Exchange opened and quickly became a force in options trading, 726.7 million contracts exchanged hands, up 43% in a single year.
The collapse of the dot-com bubble dented growth in 2001 and 2002. But trading volume expanded again with a fury as the stock market issued a game-changing follow-through day on March 17, 2003. Options volume grew at a double-digit pace every year from 2003 through 2008. In 2004, it eclipsed 1 billion contracts for the first time.
In 2022, despite a brutal bear market in stocks, total U.S. options volume reached 10.32 billion contracts, up 4.6% vs. 2021. That total includes 9.6 billion in equity-linked options, 721.2 million in non-equity options, and 55.1 million in options on futures. Tu of Cboe noted that over the years the company has accounted for nearly a third of all options trading in the U.S.
“2022 was a year of substantial progress at Cboe as we continued to build out our global network,” Cboe CEO Tilly said in a fourth-quarter news release highlighting fourth-quarter results. “We are focused on accelerating our momentum in three key areas of our business: derivatives, data and access solutions, and digital.” The firm is slated to report Q1 results on May 5.
Are Options Exchanges A Good Investment?
Earnings at the Chicago-based firm rose 6% to $1.81 a share last quarter, marking a slowdown after a 40% jump in the year-ago quarter. Revenue amped up 16% to $1 billion, stretching its streak of double-digit top-line growth to three straight quarters. Earnings have averaged 21.8% growth over the past six quarters.
Cboe stock has thrived since its Nasdaq debut in June 2010, MarketSmith charts show. It now trades on the Cboe-BATS exchange. Shares broke out of a six-week flat base on Sept. 14, 2012, with a 29.25 buy point. In February 2018, Cboe hit an all-time high 138.54, up 374% from the breakout. The S&P 500 rose 96% over the same time frame.
Today, after years of meandering action, Cboe stock looks poised to eclipse its record high.
Nasdaq (NDAQ) (which acquired the International Securities Exchange in 2016), Intercontinental Exchange (ICE) and CME Group (CME) — which also offer options trading across commodity, stock and currency markets — have posted triple-digit gains over the past decade.
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Shorter Options Expirations
The trend of options trading over shorter time periods has continued. The 2005 introduction of weekly-expiration options boosted interest and activity among traders. It also paved the way for these derivatives to cover even shorter time frames. Since 2016, options in heavily traded indexes expanded to expirations of three times a week. It was only natural for the exchanges to move toward a daily-expiration product, the 0DTE, which arrived in spring last year.
ODTEs allow investors to trade news of the day and adjust current positions.
Sosnick of Interactive Brokers says the fact that less than half of Cboe’s volume was made up of options contracts that expired in five days or less is significant. Why? Options still serve many time frames and styles of investing.
“The trend toward ever-shorter options has been underway for quite some time,” Sosnick wrote. “There is nothing specifically dangerous or systematically risky about 0DTE options, even if they have facilitated potentially unhealthy levels of aggressive speculation.”
TradeZero’s Expansion Plan
Dan Pipitone, co-founder and president of online brokerage TradeZero, wonders if intraday-expiring calls and puts might arrive in the future. The might allow investors to trade, say, just the morning or afternoon session in a stock or index. Cboe’s Tilly certainly is not ruling it out. He thinks intraday options could allow some traders to address the 24-hour news cycle.
Meanwhile, TradeZero is planning to launch spread trades on its platform in May. The homegrown software platform, according to Pipitone, is incorporating a highly conservative margin-calculation engine. That might help the firm manage leverage and risks for customers’ accounts.
Options trading “is a real bright spot for us (as trading in) equities has cooled off,” Pipitone told IBD. He also foresees a day when customers will be able to enact “fractional options” that cover equity shares in lots of less than 100.
Currently, one call or put stock option gives the buyer the right, but not the obligation, to purchase or sell 100 shares of a specified security until the contract expires.
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More Ways To Hedge Investment Positions
Some money managers, though, are not quite sold on options. Robert Maltbie, president of small- and microcap equity research firm Singular Research, argues that the liquidity and low trading costs of exchange traded funds serve investors well for both long and short strategies. Index and sector ETFs provide ways to hedge against a position.
“In the universe of microcaps, or those with market value of under half a billion dollars, they just don’t have much options traded,” Maltbie told IBD. “If you want to protect against a future drop in regional banks, you just simply sell short an ETF such as KBWB (Invesco KBW Bank (KBWB)) or IAT (iShares U.S. Regional Banks (IAT)). It’s quick, it’s simple. You don’t have to go through the machinations of picking a time expiration as you do in options. I don’t have to worry about premiums.”
Maltbie, who is also managing partner of Millennium Asset Management in Calabasas, Calif., personally uses options for specific liquid stocks. “I’ll use them to enhance the position directionally,” he said. And how about Maltbie’s high-net-worth clients? “They are too busy. They don’t even trade ETFs.”
An Education Challenge For Options Trading Strategies
Randy Watsek, principal at Birch Lane Group — a Raymond James Financial (RJF)-affiliated advisory firm in Somers, N.Y., with $200 million under management — says that when he ran a hedge fund in the early 2000s, options offered added value. Using a bearish option strategy that limits the maximum potential loss can make more sense than a short equity position, which theoretically has unlimited risk of loss.
However, Watsek thinks most financial advisors generally avoid options trading. Applicants for the Series 7 broker license get some information on options instruments. “But it’s quite superficial. There’s a big difference between knowing options and using them very well,” he said. “It takes a significant amount of training just to understand the value of options. The risks and scenarios that play out are not linear.”
He added, “There are some limited ways to use options in a low-risk way, such as covered calls. But the dangers come when you think you can get a steady stream of income. There are black swans in the market, and you cannot control for that.” The comment refers to Nassim Taleb’s book, “The Black Swan: The Impact of the Highly Improbable,” which details the impossibility of predicting all future risks in the market.
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Limits On Options Trading
Pipitone of TradeZero notes that the average account among his company’s retail customers is $10,000. He acknowledges that most options expire worthless. Yet the profit potential for a weekly option that may trade a penny or 2 cents per contract still attracts the trader who sees potential for the underlying stock to make a sudden big move. If that option can gain, say, 50 cents in intrinsic value, Pipitone says the potential reward is worth the risk in the minds of some traders.
Pipitone notes that the so-called pattern day-trading rule applies to options trading too. This rule by Finra, the self-regulating authority for broker dealers, limits intraday trades to just three round-trips over a period of five business days for accounts under $25,000.
Is this a good safeguard for investors? “100% yes,” he said.
The Value Of Options Learning
Sears of Options Solutions believes investors could boost their overall market knowledge by learning about options trading.
For instance, if retail investors learned a strategy such as covered calls, it could enhance the overall return from stocks in portfolios by 2% to 4%. Such gains could help retirees immensely. The strategy does put a cap on gains in the stock, but also carries minimal risk.
“The options market offers an ongoing master class in how to think like a good investor. Options are a way of thinking and acting as much as options are a financial product,” Sears said. “A good options investor thinks of risk before reward and process before profit. We often sum all of this up with what I call the Good Investor Rule: Bad investors think of ways to make money and good investors think of ways to not lose money.”
Please follow Chung on Twitter: @saitochung and @IBD_DChung
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