Stock Options: Secret Once Known Only to the Wealthy, Now Known to All

Updated on July 15, 2018
Daniel Mollat profile image

Daniel is a retired business executive who now devotes most of his free time to trading stocks and stock options in the stock market.

Secret No More

When stock options were first introduced in the early seventies it was immediately discovered by the wealthy few to be a great money-making instrument. It was hardly known outside the circle of wealthy stock investors, and for many years it was a secret tool used only by those in-the-know. These select group of investors became immediately aware of how to use options as a powerful tool to enhance returns on their stock investments.

It wasn’t until many years later that stock options began to gain status with the general investing public. Today, while it is still a mystery to many in the stock market investing public, it is fast becoming well-known to the common everyday stock investor as an instrument of value.

Hah! I'm your equal now, Mr. Wealthy!
Hah! I'm your equal now, Mr. Wealthy!

Brief History of Stock Options

Historically options have been around for many centuries but as it is traded today it is relatively a new phenomenon. It was in 1973 that options were born in the form that they are today. Before then options were mostly traded by farmers and commodity traders seeking price stability in their products.

They were widely traded as a means of price protection for their products. It enabled these businessmen to lock in future prices thus offering greater stability in the market. While these price protection contracts served the purpose of maintaining stability in the marketplace, they were seldom used as instruments of trade mainly because they lacked the element of liquidity.

All this changed in 1973 when the Chicago Board Options Exchange (CBOE) was created and the first options exchange came into being. The CBOE began offering listed options in a standardized form making it easy and convenient for buyers and sellers to trade these instruments and creating, therefore, a system of matching buy and sell orders quickly and in an orderly fashion.

At this point options trading was quite limited. But in 1975, the Options Clearing Corporation was created to serve as a central clearing facility for other types of options offered to the general public.

While slow to gain popularity initially, options have consistently grown acceptance among investors resulting in an explosive growth rate in the 90s which is still going on at present.

World Recognition

Among the countries that immediately recognized the benefits offered by options, Australia became the first foreign country to follow suit in 1976 when it opened its own Australian Options Market.

Seeing the success of options in the US and Australian markets, Europe rapidly followed the trend with many countries coming on board. This rapidly developing derivative product is now enjoying tremendous trading volume in countries where it has been introduced.

In Asia, Hong Kong followed several years later subsequently overtaking Australia in trading volume and today is Asia’s most active stock options market.

Today the popularity of options trading continues to grow exponentially and according to the Options Industry Council option contracts traded in the US in 2007 was nearly 3 billion whereas in 1999 it stood at a mere 507 million. This is a growth rate of nearly 600% in just seven years! In 2010 there were some 4 billion options contracts traded

So what is causing this phenomenal growth and popularity in options trading? The growth phenomenon was fired by the acceptance of the general stock investing public of the advantages presented by options trading versus the perceived risks associated with it.

Studies show that individual investors make up 60% of stock options trading.

The ability of stock options to give the investor a wide range of choices in stock market investments is what has made the options market grow by leaps and bounds over the last forty years.

Statistics compiled by the Options Industry Council, a group that educates investors about options, show that volume in options trading has risen tremendously in recent years. Further, studies show that individual investors make up 60% of the market.

"Stock options are the greatest wealth building tool ever invented on this planet … if you know how to use them"

— statement by one stock options expert

But even today, for many people, there is still the stigma of great risk associated with options. The mere mention of stock options sends shivers up their spine. They look at options as synonymous with high risk. But isn't driving a car very dangerous for one who doesn't know how to drive? Would not a person with no knowledge of driving a vehicle present the utmost risk? To quote one options expert: "Stock options are the greatest wealth-building tool ever invented on this planet … if you know how to use them." The key element of this statement is: if you know how to use them.

In the same manner, a person who knows how to drive and is well acquainted with the use of a motor vehicle is a safe driver.

For the individual who is looking for more than a decent return on his capital with controllable risk, stock options may be the answer.

Dozens of Options Trading Systems

There are dozens of option trading systems being employed by individual investors and institutions. Each system is designed to accomplish a specific investment goal.

A financial institution may use long put options, or a combination of other options strategies, to hedge its winnings in stocks that have appreciated in value. Another investor may buy call options instead of stocks to enter a position in a security that has caught his fancy. Still, another may sell calls against his stock holdings to generate income from his stock position or what is popularly known as covered call writing.

Of the dozens of options trading systems, I personally like the strategy of selling options as a long-term investment program. Selling cash-secured puts is one of my favorites together with doing credit spread trades for long-term consistency offering a fair degree of safety and more than decent returns.

Lately, I have also gotten more involved in buying calls of selective volatile company stocks as a short-term speculative play for quick profits. But as I’ve already said in many of my articles the buying of calls and puts is a straight out gambling game where one hopes of hitting more winners than losers.

What was once the domain of wealthy individuals and institutions in the stock market, stock options has now also become the tool of everyday small-time players.

Let’s look at why options trading has gotten so popular for the knowledgeable investor.

It is a well-known fact that serious investors seeking long-term growth of capital have as their main objectives the two most basic goals in investing:

  • to find an investment vehicle that would effectively preserve capital and minimize risk in the face of a fluctuating and constantly flexing economy
  • the investment vehicle must provide decent yields to promote constant growth of capital value.

With the stock market as the premiere choice, due to its historical record of outperforming all other investments over time, people are increasingly turning to the stock market as their main investment vehicle for future capital growth and steady cash flow. It is here where much higher rates of return can be made with a relatively manageable risk to capital. It is also here where stock options can play a major role in increasing investment returns and minimizing losses.



NOTE:

Any and all information pertaining to trading stocks and options including examples using actual securities and price data are strictly for illustrative and educational purposes only and should not be construed as complete, precise or current. The writer is not a stockbroker or financial advisor and as such does not endorse, recommend or solicit to buy or sell securities. Consult the appropriate professional advisor for more complete and current information.

Questions & Answers

  • I am a stock market investor. I've heard of stock options but have not really explored them. Is there any value to them?

    As a stock market investor it is a MUST for you to learn options. It is definitely a valuable tool that enhances your stock investment returns. You can use options to complement your existing stock positions or use options as independent investments in the stock market. You may want to read my article "How Trading Options Will Make You a Better Stock Investor:" http://hubpages.com/personal-finance/increase-your...

© 2018 Daniel Mollat

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