Blog - Investing Notes
October 9, 2006 - The Options Trading
Landscape
How do individuals really trade in equity options? Do they mostly just
buy speculative calls and protective puts? In their May 2006 paper entitled
"Option Market Activity", Josef Lakonishok, Inmoo
Lee, Neil Pearson and Allen Poteshman examine actual option trading
behaviors of firm proprietary traders (most sophisticated), customers
of full-service brokers (including hedge funds?) and customers of discount
brokers (least sophisticated). Using a unique dataset with detailed
purchase-write and open-close transaction information for each equity
option series listed by the Chicago Board Options Exchange (CBOE) from
1990 through 2001, they conclude that:
- Across all of 1990-2001, aggregate non-market maker open interest
(as a percentage of outstanding shares controlled) averages: 0.232%
for purchased calls; 0.282% for written calls; 0.055%
for purchased puts; and, 0.072% for written puts.
- Combined call/put written open interest (0.354%) significantly
exceeds purchased open interest (0.287%) due primarily to full-service
broker customers, who dominate open interest. In contrast, purchased
open interests of firm proprietary traders and discount broker customers
somewhat exceed their written open interests.
- Combined purchased/written call option open interest (0.514%)
is roughly four times greater than put open interest (0.127%)
across all groups of non-market maker investors.
- Only one group, firm proprietary traders, holds more purchased than
written puts.
- There are only small differences in options trading for growth and
value stocks. Full-service broker customers do sell relatively more
puts on value stocks. Option activity correlates positively with underlying
stock volatility and dividend yield.
- Volatility trading (straddles and strangles) represents only a small fraction of
option trading. Speculation/hedging regarding the direction
of underlying stock price movements is the main driver of option market
activity.
- Most call writing hedges (covers) long stock positions.
Purchased calls and written puts, however, are mostly speculations
on the underlying stock prices. Some investors use put writing
to acquire underlying stocks, especially value stocks, at favorable
prices.
- During the stock market bubble, discount broker customers
dramatically increased buying of calls and writing of puts for growth
stocks.
In summary, investors/traders write (sell) more options than they
purchase and deal much more in calls than in puts. Call writing is mostly
hedging, while call purchasing and put writing are mostly speculations
on stock prices.
For related research, see Blog
Synthesis: Equity Options. See also our blog
entry of 1/27/06 to compare the behaviors of the three investor
categories above with those of commercial traders, large speculators
and non-reportable small speculators in stock market futures.
