Over the past year, investors have been using stock options more and more to maximise their leverage and returns. Chicago Board Options Exchange recently said that March was their busiest month ever, with volume up 55% from the same month last year. This backs up what we already knew. In fact, all trading records for stock options were broken when more than 5.6 million contracts were traded in one day.
When investors trade stock options, they can use more leverage and get a higher rate of return than when they just buy and sell stocks. If an investor knows how to pick stocks that will go up in the short term, stock options can increase their returns by 10 to 15 times. The trade-off for this higher return is that the investor must also guess how long it will take for the return to go up.
For stock option trading to go well, you need to be able to choose the stock, the direction, and the time period. A recent statistical analysis of more than 30 years of stock data showed that there are some patterns that keep coming up that can lead to high returns when trading stock options. The analysis was done with software that was made just for this project, and the strategy was then used on all stocks from the last five years. In 2005, the average return per trade for stock trading was 3.2%, but the average return per trade for stock option trading was over 55%.
Investors have already started to use the patterns found in this research, and they say that their trades have been very profitable. When investors see inefficiencies in the market, they move quickly to take advantage of them.
Even though not all stocks have stock options, about half of the stocks in the study did have options that could be traded. If investors continue to use stock options more and more, even more stocks should add options for investors. If this trend keeps going, it is easy to see that 60–70% of actively traded stocks will have option contracts available in the coming year.
When deciding which option contract to buy, investors are told to pay close attention to the open interest and volume. When volume and open interest are low, the difference between the bid and ask prices is usually big. This makes it harder to make money and may also make it hard to sell the option contract.
Volatility is another thing to think about when choosing an option contract. Options on stocks with big price swings will be more expensive because there is a better chance that the options will be in the money. If you have a good way to predict how stocks will move, this higher price may not matter to you.
