An Options Trading Renaissance Is Upon Us

Exuberance brought about by massive fiscal stimulus, inflation, and FOMO has taken the market into hyperdrive. But what many outsiders unfamiliar with market mechanics don’t see is the hectic activity happening behind the scenes in the options market.

The resurgence in meme stocks like $AMC, $GME, $BBBY, and other heavily shorted names is driven by options. Options purchases from diamond-handed Redditors led to share purchases from market makers that led to more share purchases thanks to the phenomenon of the gamma squeeze. If you want to understand the market, you have to first understand the growth of options.

Options volumes head to the moon

There’s a ton of new interest in the stock market. But while stocks get all the attention as the underlying asset, more and more investors have discovered the benefits of trading options. According to the data, they’re really starting to pile in.

The world’s largest equity derivatives clearing organization, the OCC, recently announced their total exchange-listed options cleared contract volume for the month of May was 718 million. That’s a massive 32.6% jump from May 2020 and the highest May volume on record.

Equity options cleared contract volume was 678 million contracts, up 32.5% compared to May 2020. This includes an increase of 5% for ETF options and 34% for index options.

OCC’s year-to-date average daily cleared options volume is a whopping 39 million contracts. Compare that to the 29 million average daily contracts traded in 2020, or the 19 million traded in 2019. We’re on an obvious uptrend.

But why are options volumes flying off the charts? And what does it all mean for you as a trader?

Reasons for increasing options volumes

Momentum

The uptick in options volumes should be expected to a degree. Increasing volume in underlying stocks tends to come with an increase in options volume.

We’ve seen some strong returns from equities recently. The S&P 500 is up over 18% year-to-date. That’s amazing performance compared to the index’s average gain of 13.6% annually over the last 10 years.

However, according to Goldman Sachs, those returns are due to halve in the coming decade. So, with all the uncertainty ahead as we grind higher, investors are searching for trading vehicles that offer more flexibility and the potential for greater returns.

Options could be the safer play

Options trading often gets a bad rap as complicated and risky. But buying stocks at all-time highs carries its own risk as well.

Some traders feel confident in the long-term prospects of certain companies. But current share prices might just be too rich for their blood. And who could blame them at these levels? Especially if they’re expecting an eventual pullback from all-time highs.

Pete Najarian recently commented on CNBC’s Halftime Report that while he currently loves the tech sector, there’s some stocks where he’d rather just be in the options.

Pete on buying options: "I love having stock in companies like $AAPL and $MSFT. But it’s so difficult at these price levels to get involved with some other names. I’m willing to trade those stocks with options, I just don’t want to be in the stocks themselves.” @HalftimeReport

— Market Rebellion (@MarketRebels) July 13, 2021

Options offer flexibility. They give traders the ability to capitalize on a move in the stock, while limiting their exposure and oftentimes lowering their cost-basis. Sometimes it’s just better to trade with options. Especially when it comes to stocks with extremely high P/E ratios in sectors that are already considered overbought.

The rise of the retail trader

Thanks to advancements in online trading platforms and the evolution of social media news flow, the retail trader is better equipped than ever to successfully trade derivatives like options.

Just look at how sites like r/WallStreetBets and Twitter have brought retail traders together. These platforms allow users to share news and information at speeds that make them true competition for Wall Street. So, it’s really no surprise individual traders are starting to take over.

According to Rich Repetto of Piper Sandler, much of the increased options volume is being driven by these retail investors:

Options trading at retail brokers is way up. December 2020 saw an average of 32.7 million contracts traded on all the equity option exchanges, a record at the time. One month later in January, 39.8 million contracts a day were traded.

Data from CBOE indicate trading in single contract options has doubled in market share (4% to 8%) and tripled in volume in contracts per day. You don’t see an institution buying one contract.

More and more retail investors are becoming savvy options traders because it offers them more control and greater flexibility.

What options volumes mean for you

Higher options trading volumes matter because higher volumes mean competitive markets. Competitive markets equal tighter pricing. And tighter pricing results in more opportunities for you to take advantage.

So, if you’ve been looking into options trading, now just might be the best time to jump in.

But you need to beware of common mistakes many new options traders make. There are serious pitfalls that you’ll want to avoid.

So, start by learning how to trade options from seasoned pros. Check out Market Rebellion’s catalog of options trading education and services. They include resources that can help beginners learn the basics and assist veteran traders in taking their skills to the next level.