(Barrons: Steven M. Sears)
The U.S. options industry is approaching a milestone. On April 26, the industry will celebrate its 50th anniversary.
During the past five decades, options have evolved from a curiosity—traded by a few pioneering souls with great math skills in the old smoking lounge at the Chicago Board of Trade—into one of the world’s most important markets. At last count, 16 U.S. options exchanges belonged to the Options Clearing Corp., which issues and settles all options contracts.
The growth in trading volume has been astounding. In 2000, it was remarkable if a million contracts traded on a given day. Now, 45 million contracts a day often trade, and it is treated as a natural occurrence.
Still, the activity is often misunderstood. A lot of the trading volume growth reflects institutional investors using options to reshape portfolio risk and returns.
Unfortunately, the options industry has helped advance the perception that puts and calls are suitable only for aggressive speculation by introducing more options that expire in extremely short times. The short-term options-trading mania generates profits for exchanges and trading firms but at the cost of fostering misperceptions.
The investment industry—financial advisors, institutional consultants, family offices, and pensions—is struggling to understand how best to use options. A solution may soon emerge. Cboe Global Markets (ticker: CBOE), which launched the first U.S. options exchange in 1973, is planning 50th-anniversary galas in major cities. The gatherings could spark the next generation of growth. The timing is opportune.
Demographic trends, coupled with a growing need for income to fund underfunded retirements, are a major issue in the U.S. and many other countries.
People are living longer than expected. They risk running out of money. They might get lucky and capture another multidecade bull market—or not.
The need to augment traditional portfolio allocations of stocks and bonds creates an opportunity for the options industry to demonstrate the value of simple, conservative strategies like selling call options on blue-chip stocks, also called the covered-call strategy. It entails selling a call on a stock you own with a strike price about 10% higher than the associated stock price.
This allows investors to receive a payment that often compares favorably with common stock dividends, making this an ideal strategy for income-hungry retirees.
The amount of money that could be generated with the covered-call strategy might even satisfy the annual required minimum distributions that retirees take each year. The strategy should be able to increase stock returns by 2% to 4%. Other than limiting your gains if the stock rises above the strike price, the risks are minimal.
Steven M. Sears is the president and chief operating officer of Options Solutions, a
specialized asset-management firm. Neither he nor the firm has a position in the options
or underlying securities mentioned in this column.