Glyn O’Connell is the kind of customer online brokerage firms like TD Ameritrade Holding (AMTD) and Charles Schwab (SCHW) covet. “I’ve spent more than $10,000 in commissions in past years,” says O’Connell, a TD Ameritrade customer who lives in Brisbane, Australia, and moved from trading stocks to options and futures. “You can easily recover that, but it adds up.”
Brokerages including TD Ameritrade, Schwab, Fidelity Investments, E*Trade Financial (ETFC), and Scottrade are focused on expanding their businesses beyond equities as volume from stocks has sagged. Options have gained in appeal because they’re well suited to a volatile market and help hedge against declines. Not surprisingly, the number of option contracts has hit record highs.
The competition to attract and retain active traders, rather than those who buy and hold, has intensified, according to an August study by Celent, a financial research and consulting firm. While about 21 million U.S. households held stocks outside retirement accounts in 2009, less than 10 percent are active traders, according to estimates by Aite Group, another research outfit. “Options are kind of like the crack cocaine for brokerage firms,” says Andrew Stoltmann, a securities attorney in Chicago. “They’re easy money, huge commissions, and they tend to be extremely addictive for those who actually trade them.”
Options are contracts that give buyers the right, without the obligation, to buy or sell a security, a commodity, or the cash value of an index at a set price by a specific date. Investors use them to generate income, speculate on market performance, or to hedge risks. Javier Paz, a senior analyst at Aite, says investors can lose money faster trading derivatives such as options and futures if they don’t know what they are doing.
Trading volume for options has risen every year since 2002, and was up 22 percent through October, according to the OCC, the Chicago organization that clears and settles all option trades. In the first 10 months of the year, equity trading volumes on the New York Stock Exchange were down 14 percent, on average, and 9.1 percent on the Nasdaq.
The Celent study shows that option traders at Schwab, the largest independent U.S. brokerage by client assets, trade more frequently and have more assets than its average retail clients. A 2010 survey prepared for the Options Industry Council, an industry education group, found that option buyers averaged 31 trades a year, compared with 24 for other investors. Brokers like options because they generally carry higher commissions than plain-vanilla stock trades. TD Ameritrade, for example, charges $9.99 for each online stock trade, according to its website. Option orders cost $9.99 plus 75¢ per contract. Some clients are also charged a $19.99 commission at the time they exercise their options, according to spokeswoman Kim Hillyer.
To court those hooked on options, industry heavyweights are buying smaller rivals or expanding their in-house capabilities. TD Ameritrade, the No. 3 online brokerage in the U.S., paid about $750 million for Thinkorswim, an option trader, acquiring 87,000 retail client accounts, about two and a half years ago. Although some clients complained of glitches during the integration, TD Ameritrade Chief Executive Officer Fred Tomczyk says the acquisition has been a success: Derivatives trading increased to 32 percent of daily trades in fiscal year 2011 from 14 percent in fiscal 2009.
Fidelity, the mutual fund company that is also the nation’s second-largest online broker, rolled out enhancements this summer to the Web-based version of its active trader platform. The firm says average daily option trades have increased at a compound annual growth rate of about 21 percent in the past five years. In a deal that closed Sept. 1, Schwab bought OptionsXpress Holdings, which had 397,400 client accounts, for about $710 million. “Our interest in options is a direct result of client interest,” says Alison Wertheim, a company spokeswoman. “We’ve seen a much bigger appetite among affluent investors.”
E*Trade and Scottrade are hosting special events to familiarize customers with options. Still, Stoltmann, the securities attorney, believes most brokerage firms’ clients don’t really understand the potential downside of derivatives. “I don’t think most investors appreciate the true risks of these things,” he says. “It’s like rocket fuel on a fire, and people can be wiped out very, very quickly.”