Which Stocks Offer the Best Return on Option Straddles?

05/20/2010 12:01 am EST

Focus: OPTIONS

Joseph Hargett

Financial Analyst, Schaeffer's Investment Research, Inc.

While it may seem like a "no brainer" to say that options pricing can make world of difference in your trading performance, Schaeffer's senior quantitative analyst Alan "Rocky" White recently conducted a study that really hammers the point home. Specifically, Rocky drilled down on option premiums by analyzing the performance of at-the-money straddles for every stock that Schaeffer's currently tracks.

The holding period for these straddles spanned from expiration to expiration, or a duration of one expiration period (i.e. buying a front-month May straddle on April expiration and holding until May expiration). In Rocky's words, he wanted to "Find stocks that have a history of moving more than option premiums suggest they should."

To narrow the period of performance, Rocky only tested this strategy dating back to January 2009. Furthermore, he narrowed the list of study stocks by only looking at those equities trading above $8 per share, and with 10,000 contracts in total open interest. So, the study encompassed 15 expiration months, but some stocks may not have 15 returns if they dipped below $8 per share or 10,000 contracts in open interest.

The results turned up a slew of stocks whose options appear to be consistently underpriced. While the list was a bit too long to post here, the table below details returns for the top ten best-performing straddles.

Looking for a little help interpreting the data? Take a closer look at Phillips Van Heusen Corp. (PVH). During the 15 months the study encompasses, there were eight times when PVH met the criteria for a straddle (some months the stock did not have the required 10K total OI). What's more, those eight straddles would have averaged a return of 75%, with five (63%) finishing positive, while two (25%) would have doubled the initial investment. See the chart below.


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Hungry for more analysis? Now we'll take a look at the darker side of Rocky's study: Stocks whose options appear to be consistently overpriced.

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As a byproduct of his research, Rocky also uncovered a list of stocks with implied volatilities that have been consistently higher than necessary.

While the study was designed to look for stocks with consistently underpriced options, when the resulting list was turned on its head, we ended up with a list of stocks with consistently overpriced options. The table below details returns for the top ten worst-performing straddles.

Need help interpreting the data? Take a closer look at CenturyTel Inc. (CTL). During the 15 months the study encompasses, there were seven times that CTL met the criteria for a straddle (some months the stock did not have the required 10K total OI). What's more, those seven straddles would have averaged a loss of 68.1%, with not one finishing in positive territory. See the chart below.


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By Joseph Hargett, contributor, Schaeffer’s Trading Floor Blog

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