Whether you love 'em or hate 'em, options are an integral and growing part of the investment industry. According to data from the Options Clearing Corp., through which all options transactions are matched, cleared and guaranteed, 2003 was a record year for options trading, as volume hit 797 million contracts, a 2.2% increase over the prior record set in 2001.
More importantly, the resurgence seems to be accelerating, as the first quarter of 2004 has had an average daily volume of more than 5.1 million contracts -- a 63% increase, which puts it on pace for its first billion-contract year.
Obviously, you don't need to own a car to take a position in
, so even if you don't trade options themselves, it shouldn't stop you from looking for investment opportunities among those companies that operate within the options industry.
A recent report issued by Michael Vinciquerra, who covers the securities and brokerage industry for Raymond James, noted that options' average daily trading volume has been growing at a compounded rate of 123% over the last 30 years. Doesn't it seem like there should be a moneymaking opportunity within the sector?
Sweeping Changes on Floor Exchanges
One of the primary problems in finding a good investment is that there are very few publicly traded firms that are pure plays or are direct beneficiaries of the industry's growth. In fact, market-maker and specialist firms, or those companies whose revenue is most directly tied to option trading volume, are finding the economics of the business increasingly less profitable and therefore unattractive.
"There is simply not a whole lot of money to be made in the market-making industry," says Vinciquerra, adding that electronic trading, increased regulation and the move toward tighter (sometimes pennywide) bid/ask spreads have hurt profits at such places as
. (While it's not Vinciquerra's personal favorite way to play the growth in options trading, his firm does give a "strong buy" recommendation to Knight.)
As for other specialist names, Susquehanna International Group, SLK and Timber Hill, all among the largest market-making/specialist firms, are either privately held or a subsidiary of a larger firm, but all have been reducing their floor operations. And
( LAB) gets only about 5% of its revenue from options and has been under investigation for its practices on
Betting On the Brokers
A more attractive way to participate might be through the online brokerage firms. While the number of equity trades still dwarfs options orders and accounts for the bulk of these firms' revenue, the execution of options trades provides much fatter margins than stock trades. This is not going unnoticed by the major online firms, which, thanks to improved technology that makes click-and-trade and single entry multileg or spread orders possible, are bulking up their options trading tool offerings and marketing to more sophisticated and active traders.
Two of Vinciquerra's favorite names are
, saying that "as order-flow providers they directly benefit from an increase in volume." In addition, while there may be some consolidation, he doesn't foresee per-contract fees on options trades undergoing much more pricing pressure beyond the recent reductions.
I'd also suggest keeping an eye on OptionsXpress, which isn't public yet, and claims to have no immediate plans to change that fact. But it recently received a $90 million investment from Summit Partners, which will help it to sustain its impressive growth and achieve the critical mass that I believe will eventually lead to a public offering.
Going to the Source
Another place to look is at the exchanges themselves; unfortunately, the only one that currently trades publicly is the Chicago Mercantile Exchange. But given its phenomenal performance -- up some 400% since its December 2002 initial public offering -- you could expect other exchanges to follow suit.
The International Securities Exchange recently announced its intentions for an IPO to occur sometime in the fourth quarter of this year. This all-electronic options exchange has been the biggest driving force in bringing options trading into the next century, and has become the market share leader, toppling the Chicago Board of Options Exchange's near-monopolistic stranglehold in only its first three years of existence. Assuming the initial valuation isn't too exorbitant, the ISE probably will prove to be a good investment vehicle for gaining exposure to the growth of options trading.
You also may want to look at firms most responsible for bringing exchange-traded funds to market. It should come as no surprise that the success of these products has spilled into the options market and has been a large contributor to the increase in trading volume.
, king of the iShares, does have ADR shares that trade on the NYSE and that have gained about 37% over the last 52 weeks. The London-based financial services firm benefits from an increase in assets allocated to ETF funds through management fee revenue. The increased volume of both the funds and their related options is maintaining a steady trajectory upward and portends for future growth.
Besides its rising stock price, the option volume of some of its more popular iShare products, such as the
iShares Lehman 20+year Bond Fund
iShares Russell 2000
are showing year-over-year option growth of 70% to 400,000 contracts and 45% to 1.1 million contracts, respectively, for the first quarter of 2004, according to a Morgan Stanley report.
While these baseline numbers are still far below the monstrous volume posted by the
Nasdaq 100 Unit Trust
, which recorded volume of 31 million through the first quarter, that's still more volume than 65% of all listed equity options. But keep in mind that the connection between options trading and Barclay's profits is a very dotted and crooked line.
( MHP), which owns Standard & Poor's, might be another way to gain exposure to the burgeoning field of ETF trading and its related options. Unlike Barclay's, which pays various institutions to create a tradeable iShare product with instant brand recognition, S&P collects licensing fees as it leverages its name brand as the benchmark for various products. But again, trading volumes have little direct impact on revenue, and the licensing of the S&P brand name is just a tiny portion of McGraw's overall business.
Finally, I'd suggest a look at some of the investment education firms. As options trading becomes more accessible to individuals, so does the demand for knowledge. Unfortunately, there are few pure plays here; certainly McGraw-Hill supplies many investment books, software and research, but, again, this is a small portion of its overall publishing enterprise. While many of the leading education companies that focus strictly on investment education and options in particular, like Optionetics, are privately held, one firm,
, is publicly traded and might present a good way to play this growing field.
Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to