Over the past 10 years, there has been an increase in the use of options strategies. From Dec. 31, 2009, to Oct. 31, 2013, the average monthly options volume has increased 83.7% (Source: Options Clearing Council). Conversely, equity market volumes are down are since the credit crisis with the NYSE and NASDAQ off 62.0% and 16.6% respectively (Source: SIFMA).
Despite this growth, investors continue to perceive options strategies to be higher on the risk spectrum than more traditional equity or fixed income strategies. In addition, investors note high execution costs and the necessity for proper timing as reasons for caution. This month, we seek to analyze the drivers for investor reluctance to use options and aim to debunk the myths that exist regarding options-based strategies. To do so, we categorized these fears and concerns by comments most commonly made by investors regarding options.
Myth 1: “I know someone that lost a ton trading options”
In reality, this statement is often related to option floor traders and their brethren during the 1987 portfolio insurance bloodbath. Many allocators have since attached a “Don’t Touch” label to anything related to the options market. While outsized loses can occur due to naked or levered positions, many option strategies are actually used as risk mitigation strategies and the risk of loss on the option is no more than the premiums paid.
Myth 2: “Options are for hedge funds and prop desks”
While these entities certainly benefit from the use of options and have supported growth in the space since the early 1990’, their activity has not made options more risky. If anything, an increased institutional presence has provided more efficiency to the trading of options and options. Furthermore, the fact that institutional investors have embraced the flexibility of options for both alpha generation and risk mitigation reasons should increase investors’ collective comfort level about the viability of options.
Myth 3: “I don’t understand options/the Greeks”
Many investors today began their careers before options trading became part of everyday parlance in the financial markets. Today, news and print media coverage includes updates on trends and trading strategies utilizing options and futures. The days of the traditional 60/40 portfolio using stocks and bonds, while not gone, are dwindling. Investors of today must consider a multitude of asset classes and vehicle structures that were not commonly found in portfolios a mere 20 years ago.