The Options Symbology Initiative (OSI): Illustrating the Evolution of the Industry

              

The flourishing popularity of equity options, combined with the growing complexity of these derivatives, has resulted in several inescapable speed bumps for the options industry. Most notably, the current option symbol configuration is often considered confusing, and presents a number of limitations to the options market going forward – a fact that hasn't been lost on the folks at the Options Clearing Corporation (OCC).

The Options Symbology Initiative (OSI)

As we noted in October, in response to the rapid-fire pace at which the options arena has evolved over the past decade, the OCC and various industry representatives have formed the Option Symbology Initiative (OSI). The plan calls for the often enigmatic four- and five-character option symbols to be replaced with a new 21-character Symbology Key. The symbol overhaul – slated to take effect on Feb. 12, 2010 – is expected to make equity option codes more decipherable to the naked eye, and increase compatibility with some Long-term Equity Anticipation Securities (LEAPS), Flexible Exchange (FLEX) options, and short-dated options with multiple expiration dates.

For example, under the current Options Price Reporting Authority (OPRA) codes, the symbol for Apple Inc.'s (AAPL) December 250 put is AJL XE - completely obscure to the average option trader. However, in the aftermath of the OSI conversion, the symbol for the same option would look like this: AAPL 09 12 18 P 00250 000 - much more detailed and less cryptic.

Ahead of this historic industry facelift – which has been compared to the preparation for Y2K – we've decided to take a retrospective look at the road leading to the OSI's necessitation, and examine the rapid progression in the options pits during the past few decades.

The Popularity of Options

In 1973, there were fewer than 1.2 million equity options traded, according to data from the OCC. Within 10 years, the options market had expanded exponentially, with roughly 135.7 million equity options crossing the tape in 1983. By the new millennium, the options arena had crossed the half-billion marker in annual volume. Furthermore, since 2002, the popularity of these derivatives has more than quadrupled.

Boasting a front-row seat to the evolution of the options arena has been the Chicago Board Options Exchange (CBOE).

"Entering 2009, CBOE experienced five consecutive years of record trading," stated Edward Provost, Executive Vice President of the CBOE. "During this span, total volume grew from 361 million contracts in 2004 to 1.2 billion contracts in 2008, an increase of approximately 230%."

Echoing that sentiment was David Harrison, Vice President of Member Services at the OCC. "We've seen [option volume] growth rates in the double-digit percentages," he noted, adding, "Last year was a record volume year, and the year before that was a record volume year."

On a year-over-year basis, total options activity skyrocketed 25% to a record 3.58 billion contracts in the U.S. in 2008, and 2009 is on pace to set yet another record, with approximately 3 billion contracts traded so far. In fact, more than 330 million option contracts changed hands in the U.S. during just the month of October, marking the sixth most active month on record, according to recent data from the Options Industry Council (OIC). The CBOE alone saw 102 million contracts cross the tape - a 3% increase from September.

But what has fueled the escalating demand for these unique derivatives? Industry veterans have offered up a plethora of theories, but most agree on three primary catalysts: advancements in technology, the need for portfolio protection, and the availability of educational resources.

The Age of Technology

Highlighting technology's role in the expansion of the options industry, Harrison says one of the primary advantages of the so-called information superhighway is that traders now have easier access to options. Plus, thanks to the whirlwind growth of the Internet, a bevy of market-focused Web sites and online brokers – like OptionsHouse or OptionsXpress – have become staples on the Street, making it less time-consuming for investors to research picks and place orders.

"The evolution in trading technology has led to a democratization of the markets," said Provost. "Investors now have more access to market news and data than ever before, while the ability to 'point and click' has made trading more convenient."

Furthermore, more mainstream media outlets like The Wall Street Journal have started to recognize the rapidly growing popularity of options. "If anyone had said even 10 years ago that there would be a front-page article in The Wall Street Journal [September 2009] that featured the mechanics of selling equity option strangles, no one would have believed it," CBOE Chairman and CEO William Brodsky told the audience – including our own Bernie Schaeffer – at a recent industry conference in New York.

A Growing Need for Protection

Plus, as the Internet and financial institutions have started pushing options into the mainstream, the "Average Joe" trader has become less intimidated by these unique derivatives. In fact, as OptionsHouse CEO George Ruhana pointed out, during the past few years, "options trading volume has grown at a higher clip than stock volume."

In light of this increasing exposure, investors have begun to recognize the many advantages of trading options – not only in the leverage they provide, but also in their role as portfolio protection.

The growing need for risk management is even more evident when looking at option volume trends since 2000. As highlighted in the chart below, at the height of the financial crisis in late 2008, exchange-traded fund (ETF) and index options – which are often utilized as stock-portfolio hedges – were actually more popular than equity options for the first (and only) time on record. In other words, in the wake of broad-market and economic uncertainty, traders have rushed to protect their investments by employing options.

Educating the Masses

Finally, the majority of seasoned option players also attribute the rapid growth of the options industry to the accessibility of educational resources. Over time, "there has been more and more options education available to the market – like the information you provide at Schaeffer's and from the Options Industry Council," Harrison noted in a recent interview.

In that same vein, Provost says the convenience of electronic trading, juxtaposed with the proliferation of educational resources online, make for a powerful one-two punch. The combination has "made it easier for investors to learn and become better informed," and, more importantly, "has enabled investors to become more empowered and self-directed when managing their investments."

Some could argue that the "self-empowerment" is reflected in options speculators' growing appetite for non-vanilla trading. In other words, the expanding fondness for more advanced strategies – like the vertical spread highlighted in Schaeffer's SENTIMENT magazine – is likely attributable to the array of educational resources at the Street's fingertips, which has allowed rookie traders to become more comfortable with intricate option plays.

"We have seen more people do spread trading and other strategies that are different from the historical buy-write/protective put," said Ruhana, commenting on the recent trading trends at OptionsHouse.

Stay Tuned to SchaeffersResearch.com

Regardless of the speculative cocktail of catalysts, one thing remains certain: the popularity of options has increased exponentially in the past decade, and there's no sign of the industry growth slowing down. As such, the Street is adapting to the progression in the options pits with the Options Symbology Initiative, which is expected to simplify a number of operations going forward, and make the options arena even more inviting for both rookies and veterans alike.

Looking ahead, as the No. 1 site for options traders, Schaeffer's Investment Research is committed to keeping our customers up to speed on the transforming face of the options arena. In case you missed it, check out a recent overview explaining the Option Symbology Initiative, which illustrates how option symbols will appear after the Feb. 12, 2010 switch. Plus, stay tuned for more on the Initiative – including articles on how the switch will impact brokers and exchanges, and – most importantly – what the Initiative means for you, the option trader.