Trading in options on exchange-traded funds is soaring.
Based on data provided by the Options Clearing Corporation, volume in ETF options is ripping this year, leaving index options behind. The run-up continues a multi-year trend.
Market volatility and good liquidity play a large role.
"We’ve seen a huge influx recently into ETF products because of volatility," Kevin Fischer, head of block trading in the options department at Interactive Brokers/Timber Hill, said at a recent industry conference.
Volatility, as measured by the VIX index, spiked in mid-March due to the crises in Japan and Libya, sending options on the SPY ETF, for instance, soaring. But the recent cycle in volatility has been under way since June 2007, according to analysts at MKM Partners. That’s spawned interest in ETF options for hedging and speculating.
For the first three months of 2011, ETF option volume is up by 37 percent, compared to the same period last year, according to the OCC. At the same time, volume growth in index options, an older competitor product, has been considerably slower, coming in at about six percent.
ETF options and index options are similar-the underlying ETFs often track indices-and compete with each other to a certain extent. The largest index option is the SPX, based on the S&P 500 Index. The largest ETF option is the SPY, or the S&P 500 SPDR Trust. The two contracts are similar although the index changes price only once a day while the ETF fluctuates throughout the day.
Trading in options on ETFs long ago overtook trading in index options. Daily ETF contract volume now dominates index volume. ETF options trade, on average, six million contracts per day. Index options trade an average 1.2 million contracts a day.
During the first quarter of this year, an average of about 2.2 million SPY contracts traded every day. By contrast, the SPX traded an average of about 666,000 contracts every day. The SPX is traded only on the Chicago Board Options Exchange, which holds an exclusive license.
According to Fischer, the popularity of ETF options over index options has a lot to do with their tighter spreads. That becomes apparent especially during periods of high volatility, he explained.
"In tough times," the trader told the crowd at the annual conference of the New York chapter of the Security Traders Association, "you’ll see spreads on older products such as the SPX widen from 30 cents to five dollars. By contrast, spreads on options on the Spider ETF will move from one cent to three cents. Spreads on some products-single name indices especially-are sometimes five times or ten times wider than comparable ETFs."
Still, at least one index option shows no signs of slowing down during volatile times. The CBOE’s contract on the VIX index, the universal measure of market volatility, traded a record 1.15 million contracts on March 15, in the midst of the recent crises, according to the exchange.
