After small-time options players were scalped in the 1987 crash, Chicago Board Options Exchange Vice-Chairman William C. Floersch might well have been a candidate for scalping himself. Options pros such as Floersch have always insisted that options are a smart choice for a wide range of investors--an argument that has met with a hostile reaction in recent years. But when Floersch went for a haircut the other day, he unexpectedly found himself explaining options to the barber's cousin, who was helping out in the shop. "People are much more receptive," marvels Floersch. "The options business is back."
Fueled by a fresh onslaught of investors, small and large alike, options trading is indeed on the rise. In 1993, options volume rose 15% over 1992, reaching levels not seen since the 1980s (chart). And although volume is still far below 1987 levels, the momentum continues to build. An effort to revive the business after the crash has yielded a huge crop of fresh products, including newly listed options on hundreds of companies.
WIDE SWINGS. With technology stocks growing stronger again and mergers on the rise, investor interest in options has returned. Many are buying put options--the right to sell a stock at a specific price--to protect against losses in their high-flying portfolios. Bullish traders are buying calls--the right to buy a stock at a specific price--in the hope that stocks will continue surging. A 10% rise in the price of the stock over a short period can send the call option rocketing 100% or more. For Chicagoan Sam A. Gambacorta, who buttonholed Floersch at the barber shop, options allow short-term speculation "without putting up a whole lot of money," he says.
Even though the overall market has not been that volatile, stocks in the news have gyrated. And that has been a boon to options trading. For instance, volume in Motorola Inc. options soared to 2.3 million contracts, from 605,000 the year before. Merck & Co.'s volume climbed to 2.3 million, from 1.6 million, and Intel Corp.'s rose more than fourfold, to 3.8 million. Options on Paramount Communications Inc. hit 3.3 million, up from just 200,000 in 1992.
But speculation still hasn't reached the frothy levels of 1987. Unlike options on individual stocks, index option trading has posted only modest gains, with volume in the CBOE's benchmark S&P 100 growing just 2.6% in 1993. Interestingly, put volume outpaced call volume by nearly 10% as investors hedged against a possible market correction. Market watchers note that high put volume is a sign of small-investor bearishness--which contrarians view as bullish.
On the trading floors, market makers and specialists are noticing increasingly sophisticated options strategies as well as more large orders. One reason is stepped-up participation by big players. At the CBOE, the nation's largest options exchange, institutions account for as much as 40% of volume, up from 10% six years ago. About 20% of customer orders originate outside the U.S., including those from booming offshore funds.
New products have helped draw many customers. In the midst of the industry's slump, the Securities & Exchange Commission changed its rules to make hundreds of smaller stocks eligible for options trading. After the crash, the number of option stocks more than doubled, to 1,294, at the end of 1993, and the rapid expansion continues.
The industry is also becoming more creative. The American Stock Exchange reports strong demand for its year-old "SPDRS" product that, in effect, lets investors trade shares in the Standard & Poor's 500-stock index. Lately, the exchanges have rolled out options on new indexes, country funds, and American depositary receipts from foreign companies. The biggest success has been long-term stock options known as LEAPs. Since their 1990 introduction, LEAPs have grown to more than 4% of equity options volume. LEAPs are available on 150 of the most widely traded stocks.
LAST HURRAH? All this action has the exchanges feeling flush. In the past year, membership prices soared 32% for a CBOE seat, to $331,100, and 78% for an American Stock Exchange options seat, to $142,000. Brokerage firms such as Merrill Lynch & Co. that backed off from retail options after the crash now push the business again, despite stiffer margin requirements. But firms also complain that the exchanges list too many inactive products, making it impossible to keep track of every new option. And the recent burst of creativity may be petering out. As Nobel laureate Merton Miller, a University of Chicago finance professor, puts it: "There's a limited amount of product innovation they can do, and they've done it."
For now, though, the new products still have room to grow. Industry honchos, meantime, want to make sure today's customers won't be exposed to runaway losses as in 1987. After his haircut, Floersch urged investor Gambacorta to try out a conservative spread strategy to reduce risk by buying puts and calls simultaneously. Gambacorta, who took the advice, is realistic about the options game: "You need to have some tolerance for being able to take a loss," he says. And, the industry hopes, keep coming back for more.