What's the Better Buy: Expensive or Cheap Options?

The meme stock craze is back, with usual suspect GameStop (GME) exploding higher earlier this week after one of the key figures in the 2021 mania returned to social media. While GME options are notoriously expensive, they are now paying off in a huge way.

This brings up a trade-off options traders are constantly facing: Should you buy stocks with expensive options (high implied volatility (IV), in which the underlying stock has to make a substantial move to make a profit), or cheap options (in which a relatively small move can yield a substantial return)?

In the analysis below, I’m going to look at data since 2023 to determine whether options buyers are better off with cheap or expensive options.

Expensive Options vs. Cheap Options 

I went back to 2023 and found all stocks that had expiring options each week. I assumed we purchased a straddle at the end of the week prior, then closed it at intrinsic value on expiration day. In short, for this analysis I will be looking at one-week straddle returns. 

Each week, I separated the stocks into five buckets based on the IV of the options. In the tables below, the first bucket contains the with the lowest IVs, and bucket five has the highest IVs.

I also summarized these returns by volatility bucket, with the lowest IV stocks in the first row and then subsequently higher IVs moving down the table. I show the average IV for the straddles for each bucket.

Despite the recent move in high IV meme stocks, the data below shows low volatility stocks have had more profitable options since 2023. The lowest IV bucket straddles averaged a gain of 2.29%, while straddles on high IV stocks averaged a 2.43% loss.  

We see options on low IV stocks have done better than those on high IV stocks. The percentage of positive returns are relatively similar, and while the low IV stocks had a higher percentage of straddles that doubled (a return of 100% or more), it wasn’t that much higher (11% to 9.8%). 

Before I break these down further, I want to give the disclaimer that these are the numbers from 2023, and different trading environments can yield different results. So, while low IV names have been better for options players since 2023, that might not be a good indication of what to expect going forward.

What I was most interested in before I began this study was not the average return or percent positive, but the distribution of returns for the buckets. The “Percent Doubled” column in the table above gives a little taste of the distribution.

The table below gives a fuller picture. I was curious if huge winners were more likely from high IV stocks (like the recent returns on meme stocks), or if low straddle prices would shield the low IV stocks from extreme losses.

The next table shows the distribution of the straddle returns. For the lowest IV stocks, 31.9% of the straddle trades suffered a 50% loss or worse. That is the lowest of all the buckets. The highest IV stocks showed 32.6% of their straddles losing at least half their value. That’s not a huge difference. It’s less than one extra 50% loss over 100 trades for the high IV stocks.

The biggest difference, and the reason the low IV stocks outperform the high IV stocks is the percentage of huge 200%+ winners. That low IV group had 3.2% of trades at 200% or more, while the high IV group had 2.1%. That doesn’t seem like a big difference, but that’s more than one extra trade that has a gain of 200% percent over the course of 100 trades.

The average return for a trade over 200% was 293%. If that top group gets a 293% winner, then that bottom group is handed an 8% loser (the average return on other trades), which is a 3% difference in average return over 100 trades.

The table above shows the low IV stocks have an average return of 2.29% vs. a 2.43% loss on average for the high IV group -- a difference of 4.72%. Most of the difference is because the low IV group had that extra 200%+ winner.

Finally, here are some more numbers for the IV buckets. What I find most interesting is the call and put returns for each of those buckets. The market has done very well since 2023, so call options have been very profitable while put options have struggled.

For the low IV group, however, put options were basically breakeven. The call options lagged compared to most of the other buckets, but because almost nothing was being lost on put options, the straddles outperformed for that group.