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The Easiest Way To Profit From The 'Options Boom'

By: StreetAuthority
Posted: 8/28/2013 3:30:00 PM
Referenced Stocks: CME;ICE;SPX

One of the few certainties in themarket is that investorswill always search for new ways toprofit . And there is one strategy that continues togain popularity.

That's because it enables investors to makemoney regardless ifstocks go up or down. It also provides the potential for investors to score biggains 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 ( CME ) and Intercontinental Exchange ( 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 (Nasdaq: CBOE ) is the undisputed leader in the domestic options market, boasting 28%market share whileoffering options onequities ,equity indexes and exchange-tradedfunds (ETFs ). Founded in the early 1970s, the company went public just three years ago, cashing in on the trend of financial exchangesgoing public .

Much like the stocks of other financial exchanges, CBOE has been surging in 2013, withshares up 61% on theyear . Take a look at the big gain below.

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 tocash in on the growing popularity of options and increased market volatility.

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 itsVIX (volatilityindex ) contract, with bothfutures and options trading volume exploding in the past year.

July trading data showed thatVIX futures volume was up 53% from last year, while VIX options volume was up 36%. That has VIX futures volume up 99% on the year from 2012, already breaking 2012's volume record in the first eight months of the 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 investorshedge unwanted portfolio risk.

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

Looking tocapitalize on the big popularity spike in VIX futures and options, the CBOE is on schedule to extend VIX futures trading by 45 minutes from its current closing time in September. Phase 2 of the initiative will enable its European clients to trade during regular domestic hours.

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 ( SPX ) contract. Through July, trading volume in the weekly SPX contracts was up 147% from last year, nowaccounting for 25% of total SPXrevenue as opposed to just 15% in 2012 and 9% in 2011. 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 ofearnings growth has strengthened the CBOE's financial profile. It has cash and equivalents of $208 million with nolong-term debt . That led CBOE to increase itsdividend by 20% last year to 18 cents, yielding 1.4%. It will alsosupport additional shareholder value, with $100 million remaining on the board's $200 million share repurchase program.

The CBOE could also be anacquisition ormerger target. The financial exchange industry has gone through a massivewave ofconsolidation in the past five years that is stillin play . The CBOE's options business would be a highly attractivediversification strategy for an international futures or equity exchange.

The encouraging outlook has theconsensus estimate calling for 19% earnings growth in 2013, 16% earnings growth in 2014 and 13% annual earnings growth in the next five years.

Risks to Consider: CBOE has been surging in 2013, with shares up 61% in the past seven months. Although the 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, lifting shares to a 61% gain in 2013. But with high margins, barriers to entrance and a strong financial profile this is also a company to own for the long haul. With a forwardP/E (price-to-earnings) ratio of 24, 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.