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The Easiest Way To Profit From The 'Options Boom'

Monday, March 17, 2014 - 7:00am

One of the few certainties in the market is that investors will always search for new ways to profit. And there is one strategy that continues to gain popularity.

That's because it enables investors to make money regardless if stocks go up or down. It also provides the potential for investors to score big gains with very little risk.

I'm talking about options. In response to market volatility and uncertainty in the past four years, options strategies continue to gain popularity with both institutional and individual investors.

While that has been beneficial to leading financial exchanges such as CME Group (NYSE: CME) and Intercontinental Exchange (NYSE: ICE) that carry options contracts, there is another financial exchange that offers unmatched exposure to growth in options trading volume.

The Chicago Board of Options Exchange is the undisputed leader in the domestic options market, boasting nearly 30% market share while offering options on equities, equity indexes and exchange-traded funds (ETFs). Founded in the early 1970s, CBOE Holdings (Nasdaq: CBOE) went public just a few years ago, cashing in on the trend of financial exchanges going public.

Much like the stocks of other financial exchanges, CBOE has been surging since the start of last year, with shares more than doubling in that time.

But the CBOE is different than the other publicly traded financial exchanges. As an options specialist, the CBOE is the purest play on the options market. That places the exchange in a unique position to cash in on the growing popularity of options and increased market volatility.

© Chicago Board of Options Exchange
The trading floor of the Chicago Board of Options Exchange in 2007.

And that's exactly what is happening. The CBOE continues to see impressive results from two of its most important proprietary contracts.

The first is its VIX (volatility index) contract, with both futures and options trading volume exploding in the past year. The growing popularity of the CBOE's VIX complex is a powerful engine of growth as traders continues to search for more opportunities to speculate on volatility and investors hedge unwanted portfolio risk. Recently, CBOE's CEO said the exchange plans to implement nearly nonstop trading on VIX futures by the end of the year to tap into trading in Asia.

The CBOE is also seeing impressive gains with a new line of weekly contracts linked to its high volume and extremely popular S&P 500 (IND: SPX) contract. CBOE has noted that growing interest from retail investors has fueled the popularity of the weekly expirations, and has plans to launch a new daily contract that should provide stimulus for additional volume and revenue growth.

The recent string of earnings growth has strengthened the CBOE's financial profile. It has cash and equivalents of $221 million with no long-term debt. That encouraging financial picture has the consensus estimate calling for earnings growth of 16% in 2014 and 13% a year during the next five years.

The CBOE could also be an acquisition or merger target. The financial exchange industry has gone through a massive wave of consolidation in the past five years that is still in play. The CBOE's options business would be a highly attractive diversification strategy for an international futures or equity exchange.

Risks to Consider: Although CBOE's valuation still looks reasonable, that gain has not been accompanied by equal earnings or projected earnings growth. A pullback could trigger a wave of profit-taking.

Action to Take --> The CBOE is benefiting from growing interest and trading volumes in options, but with high margins and barriers to entrance and a strong financial profile, this is also a company to own for the long haul. With a forward P/E (price-to-earnings) ratio of 22.6, in line with its peers but a premium to its higher-growth 10-year average, shares look a bit extended in the short run, making any weakness a chance to buy.

This article was first published Aug. 28, 2013.

P.S. Why have options become so popular? One reason: When used correctly, they can multiply the earnings stream from income-producing stocks. That's why I've drawn on my experience as a trader to develop a proprietary three-step system that turbocharges the income you can receive from the highest-quality and most reliable stocks in the world. To learn how to make this strategy work for you, click here now.

Michael Vodicka does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.