CBOE Holdings, Inc (NASDAQ:CBOE), which operates the largest options exchange in the United States, has done very well in recent years. In fact, the company has exceeded analysts’ expectations in 8 of the last 9 quarters. As a result, shareholders have been handsomely rewarded. Since the “streak” of good quarters began, shares have risen from a low of $19.60 to the current level of around $34.00, a gain of over 73% in little more than two years. With CBOE set to report earnings on Friday, I think this company has some major tricks up its sleeve to keep the growth going.
The Company
CBOE operates the Chicago Board Options Exchange, as well as C2 Options Exchange and CBOE Futures Exchange. The company lists options on individual stocks, market indexes, and securitized baskets of assets (like ETF’s), and offers both electronic trading and trading on its floor in Chicago.
CBOE is by far the largest options exchange in the U.S., with a market share that has hovered around 30% for the past five years now. Among its proprietary products are S&P 500 index options, the most widely traded options on the market and the CBOE Volatility Index options, which have soared in popularity and relevance since the financial crisis as the “indicator of fear in the market.”
Options are arguably the fastest-growing aspect of the investment world, becoming more popular every day due to their exciting nature, huge profit potentials, and for their very practical use for hedging portfolios and creating income in the way of selling calls. Just turn on CNBC or any of the other financial news sources. It seems like options are becoming part of more and more discussions as time goes on.
Growth
Some investors consider it a major red flag that total options volume in 2012 was down approximately 7% from the year before. I believe this is a direct result of the recovery taking effect and less volatility in the equity markets, and not a loss of interest in options trading. I personally think options volumes will begin to increase again as the market rises, as more equity investors will enter options contracts as a “hedge” to protect their profits.
What should really drive growth going forward are the company’s two major developments for 2013. First, the company is opening up a new trading hub, which will greatly increase the amount of trading volume CBOE gets from European investors.
Second, and most significantly, the company plans to introduce 24 hour a day options trading for 5 days a week, beginning this year. Up until now, Asian and European investors who wanted to hedge their bets on U.S. stocks had to do so during normal market hours. This could be absolutely huge! Look for the company to possibly provide more concrete details on this, especially regarding the timeframe for implementation.
Valuation and Competition
Although CBOE trades at a lofty P/E ratio of 20.6 times earnings, I believe that this is completely justified, and perhaps even a little cheap. First off, CBOE has an excellent balance sheet, with $160 million in cash on hand and no debt, a position that most likely has improved since last quarter. The company has an excellent buyback plan in place, and has reduced the number of shares outstanding by 13.8% in the past two years.
Additionally, the company is projected to grow earnings rapidly over the next several years as it transitions to 24-hour trading. Consensus estimates (which I think are a little too conservative in this case) call for earnings growth of 12.1% and 14% for the next two years, which more than justifies the multiple.
