How to Find the Best Stocks for Options Trading

At Schaeffer’s, we focus on options trading. Even though the value of an options contract is based on the price of the underlying stock, a skilled stock picker is not always a profitable options trader.

The main difference is that options have expiration dates. Therefore, an options trader must not only be on the right path, but must also set the timing. Strike prices and implied volatilities are two other factors that an options trader must consider that stock traders do not.

Ultimately, impressive stock returns don’t translate into great options trading. This week, I’ll give examples of when stock and option returns have diverged, and I’ll share a tool we use to find the best stocks to trade options. I will also provide a list of stocks that have been the best for options trading over the past year.

Options vs. Stock Trading: An Example

The chart below shows performance over the past year for Microsoft (MSFT) and NetApp (NTAP). An equity investor would have done slightly better with NTAP (+22%) than with MSFT (+19%), but options traders might have had very different experiences.

return from previous year

Let’s look at short-term call option trades on these two stocks. To do this, I looked back over the past year and discovered every day that there was an option that was exactly at par and expired in 21 trading days, or about a month. To evaluate the hypothetical options, I looked at the implied option volatilities on these stocks for the options closest to parity and one month from expiration.

Both MSFT and NTAP increased by approximately 20% over the 12 month period analyzed. The table below summarizes the performance of short-term buy trades over the same period. MSFT call traders saw an average gain of 45.6% per trade, but NTAP call traders saw an average loss of 18.4%.

Even if the stocks gave the same returns, the MSFT call option traders would have massively outperformed the NTAP option traders. One reason is that MSFT had lower implied volatility than NTAP (23.5% vs. 36%). This means that if these two stocks rise by the same amount, options on MSFT will be more profitable than NTAP.

summary of call option returns

summary of call option returns

Find stocks to trade options

At Schaeffer’s, we’ve created a tool to find stocks that have been best for options traders, or stocks with undervalued options. We call it Schaeffer’s Volatility Scorecard (SVS).

The essence of the calculation is similar to the analysis above, except that instead of looking at the performance of hypothetical call options, we have also assumed the purchase of a put option. This gives us hypothetical straddle returns over the past year that benefit from large moves in either direction.

We consider the average return and consistency of positive trades among other things from these hypothetical overlaps to arrive at a single number that we call the SVS. The SVS ranges from 0 to 100. Below are some lists of actions using data from the SVS calculations.

I have filtered all of these lists to show only stocks with sufficient options liquidity. First, the 20 stocks with the highest SVS. These are stocks with undervalued options over the past year.

The last column is the percentage of hypothetical straddle returns that were positive because of the call option or because the stock price rose. The higher the value, the more bullish the stock.

One thing I didn’t mention is that we also take into account the current price of cheap options compared to last year. This is why stocks with overlaps that did not perform as well might still be ranked above stocks with overlaps that performed better.

actions with the highest svs

actions with the highest svs

Below is a list of stocks that have a high SVS (at least 85) and have the highest percentage of positive returns due to call options. For this list, I eliminated the oil, gas and coal sector, which dominated the list due to the nature of this sector over the past year. This is a handy list for bulls looking for stocks to trade options on.

bullish stocks with high sv

bullish stocks with high sv

For options bears, here is a list of stocks with a high SVS that have been profitable mainly due to the stock’s fall.

bearish stocks with high svs

bearish stocks with high svs

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