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.
