Another Banner Year for Options

This column was originally published on RealMoney on Jan. 5 at 11:03 a.m. EST. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

While it may not receive the same amount of coverage as the investment-banking league tables, the Options Clearing Corp.'s year-end tally of volume and exchange market share is widely anticipated within the options industry. According to the numbers, 2006 was another banner year, with total options volume hitting a record 2.02 billion contracts. That's a 35% increase over 2005 and marks the fourth consecutive year of 30%-plus volume growth.

Finding Common Ground

Once again, the big drivers include the increasing role of hedge funds, which now make up nearly 25% of trading volume in both equities and options, and the adoption by traditional mutual funds of options as a tool for generating income and reducing risk. This is most evident in the growth of covered-call and buy-write funds, which have raised some $100 billion over the past two years.

In addition, there has been a trickle-down effect, as retail investors also embrace options for money management rather than pure speculation. In fact, a recent survey by Schwab (SCHW - Cramer's Take - Stockpickr) of 2,000 of its option clients revealed that more than half use options for income generation and some 46% are using options as part of their retirement-planning portfolio.

Thanks to entry into options by mainstream brokers such as Schwab, E*Trade (ET - Cramer's Take - Stockpickr) and OptionsXpress (OXPS - Cramer's Take - Stockpickr), which have all emphasized educational and trading tools, options are slowly but finally shedding their "too risky" and "too complicated" labels. The steep drop in commission rates has also been instrumental to overcoming costly barriers to entry, as options-trading fees are now basically in line with equity transactions.

The continued growth of exchange-traded funds has provided an efficient vehicle for both professional money managers and self-directed traders to use options. ETFs such as the Spyder Trust (SPY - Cramer's Take - Stockpickr), the Nasdaq 100 Trust (QQQQ - Cramer's Take - Stockpickr) and iShares Russell 2000 Index (IWM - Cramer's Take - Stockpickr) are typically the most-active options, trading collectively an average of more than 350,000 contracts a day.