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Exchange-traded products span a wide range of offerings, including broad style, sector, industry, country, regional and cross-asset benchmarks. A key reason for their popularity is convenience. Because exchangetraded products trade and settle like a stock, there is no additional infrastructure or documentation required. The most popular exchange-traded product is the exchangetraded fund. For the remainder of this piece, for readability and familiarity, we use the term “ETF” to mean exchangetraded fund and to include other exchange-traded products such as exchange-traded notes (ETNs). Since the credit crisis, with cross-asset correlations rising, there has been increased demand for investments with broader access. As a result, hedge funds and traditional institutional investors increasingly are using ETFs. Common applications include allocating assets, top-down investing, cash flow management, hedging either broadly or tactically within sectors and executing relative value strategies; for example, trading a stock versus its own sector. ETFs offer flexibility, and given that the products trade like ordinary equities, some institutions that are restricted from using traditional derivatives are able to use ETFs. Along with growth in the ETF market, there has been a similar rise in the use of options on exchange-traded products. The goal of this report is to examine the size, growth and breadth of the ETF options market and then provide examples of options strategies this market now allows. The analysis that follows uses a universe of ETF options whose underlying ETF country of domicile is the United States and that which is traded in U.S. dollars. We exclude ETFs for which the median daily notional option volume to date (Sept. 7) as of 3Q12 is not at least $10 million. The ETFs with options that meet these criteria are in Figure 1, with their respective third-quarter 2012 (todate) median daily notional volume. The ETF options market has been growing through the last decade, with offerings now available across a wide range of equity, commodity, fixed-income and currency ETFs. Consequentially, a liquid and broad ETF options market now allows for options strategies such as cross-asset hedging, overwriting or relative value—traditionally placed at the single-stock and index level within equities—to now be applied at a style, sector, industry, country, regional or cross-asset level. The remainder of this piece is in two parts. We survey the market of options on exchange-traded products, examining the market size, growth and depth. Then, we list and explain examples of strategies that the options market on exchange-traded products now allows. ETF OPTIONS MARKET SNAPSHOT Market Size, Growth And Breadth Market Size And Growth Over the last year, the total notional traded on ETF options has ranged from approximately $40 billion to $50 billion per day (Figure 2). For perspective, listed S&P 500 index notional option volume ranged from about $80 billion to $95 billion Figure 1 US-Listed ETFs Traded In USD With Median Daily Notional Volume Of At Least $10M Ticker Description 3M Median Volume ($M) SPY SPDR S&P 500 $26,295.52 IWM iShares Russell 2000 $3,392.05 GLD SPDR Gold $2,433.35 QQQ PowerShares QQQ $2,234.77 DIA SPDR DJ Industrial Average $691.75 EEM iShares MSCI Emerging Markets $614.11 TLT iShares 20+ Year Treasury Bond $601.52 EFA iShares MSCI EAFE $322.66 XLE Energy Select Sector SPDR $290.71 EWZ iShares MSCI Brazil $278.50 SLV iShares Silver $274.45 FAS Direxion Financial Bull 3x $261.09 USO United States Oil $240.57 FXI iShares FTSE China 25 $237.20 GDX Market Vectors Gold Miners $230.50 VXX iPath VIX Short-Term Futures $226.00 FXE CurrencyShares Euro $170.33 IYR iShares Dow Jones Real Estate $157.15 XLF Financial Select Sector SPDR $138.58 XLI Industrial Select Sector SPDR $114.98 UNG United States Natural Gas $82.16 XRT SPDR S&P Retail $79.74 TNA Direxion Small Cap Bull 3X $78.23 SSO ProShares Ultra S&P 500 $69.78 XOP SPDR S&P Oil & Gas $66.13 SDS ProShares UltraShort S&P 500 $64.63 TBT ProShares UltraShort 20+ Yr Treasury $52.25 TZA Direxion Small Cap Bear 3X $51.07 XLB Materials Select Sector SPDR $47.36 FAZ Direxion Financial Bear 3X $46.92 XME SPDR S&P Metals & Mining $43.99 OIH Market Vectors Oil Service $43.11 XLV Health Care Select Sector SPDR $36.71 XLK Technology Selet Sector SPDR $31.11 MDY SPDR S&P MidCap 400 $29.96 AGQ ProShares Ultra Silver $22.62 XLU Utilities Select Sector SPDR $22.14 XLP Consumer Staples Select Sector SPDR $20.94 FXA CurrencyShares Australian Dollar $19.72 XHB SPDR S&P Homebuilders $17.73 HYG iShares iBoxx High Yield Corporate Bond $17.54 FXY CurrencyShares Japanese Yen $17.48 IBB iShares Nasdaq Biotechnology $17.25 XLY S&P 500 Discretionary Sector $15.24 QID ProShares UltraShort Nasdaq 100 $14.18 GDXJ Market Vectors Junior Gold Miners $12.30 SPXU ProShares UltraPro Short S&P 500 $11.17 EWW iShares MSCI Mexico $11.13 ERX Direxion Energy Bull 3X $11.11 EDC Direxion Emerging Markets Bull 3X $10.99 Source: BofA Merrill Lynch Global Research Note: Volume data covers June 30 - Sept. 7, 2012. www.journalofindexes.com November / December 2012 11
Figure 2 Median Notional Volume ($B) 70 60 50 40 30 20 10 Source: BofA Merrill Lynch Global Research Note: Q3-12 data is as of Sept. 7, 2012. Figure 3 4% Median Daily Notional Volume Per Quarter, Q1-99 To Q3-12 ($B) 0 Q1 ’99 ’99 Q4 ’00 Q3 ’01 Q2 ’02 Q1 ’02 Q4 ’03 Q3 ’04 Q2 ’05 Q1 ’05 Q4 ’06 Q3 ’07 Q2 ’08 Q1 ’08 Q4 ’09 Q3 ’10 Q2 ’11 Q1 ’11 Q4 ’12 Q3 ■ SPY ■ IWM Source: BofA Merrill Lynch Global Research ■ QQQ ■ GLD ■ Other ETF Option Notional Traded Per Day By Asset Class, Excluding Top Four Traded ETF Options Outside the top four traded ETF options, there is currently close to $6B options notional traded per day in the remainder of liquid ETF options with oferings across four asset classes. 10% 11% 75% ■ Equity $4.416M ■ Debt $671M ■ Commodity $620M ■ Currency $208M Excluded: SPY $26,296M IWM $3,392M GLD $2,433M QQQ $2,235M (the largest of all equity indexes globally) per day for the same period. 1 Notably, approximately 85 percent of the total ETF options volume is traded among only four ETFs. These top four most-liquid ETF options are on SPY (S&P 500), IWM (Russell 2000), QQQ (Nasdaq 100) and GLD (gold). ETF options on SPY grew considerably from 2007 to 2011, and currently trade with one-third of the volume of S&P 500 index options. ETF option volume peaked in the third quarter of 2011 at approximately $66 billion in notional per day. ETF options volumes, like those across other asset classes, have been declining over the last year, as markets appear exhausted from ongoing and lengthy global macroeconomic concerns. Notably, volume contracted to $18 billion in the second quarter of 2009 (credit crisis market bottom) and then increased sharply (3.5 times more) to peak in the third quarter of 2011. After the credit crisis, market participants became increasingly macro focused and topdown looking, which increased demand for tools that access macroeconomic views. Growth in SPY options volume has outpaced the growth of the total volume traded in listed S&P 500 index options, in part because ETF options allow for more accessibility than index options, as they are denominated on a smaller notional. Market Breadth A key feature of the ETF market is the accessibility to trade nonequity assets in an equitylike fashion. ETFs allow investors to take views on fixed income, commodities and currencies with the same mechanical and infrastructural simplicity as when taking views on stocks. Similarly, within the ETF options market, investors can now take advantage of the benefits of optionality across a variety of asset classes. Even though the majority of ETF options volume is concentrated within four ETFs (three are equity funds; the other is gold), there is close to $6 billion of options notional traded per day in the remainder of liquid ETF options (Figure 3). Of the remaining ETF options volume, 75 percent ($4.4 billion) is in equity funds, 11 percent ($671 million) in fixed-income funds, 10 percent ($620 million) in commodity funds and 4 percent ($208 million) in currency funds. In the next section, we take a closer look at size and growth in ETF options within each asset class. SPY, IWM and QQQ the most liquid ETF options within equities: Options on equity-based ETFs have approximately $36 billion notional traded per day with the SPY (S&P 500), IWM (Russell 2000) and QQQ (Nasdaq 100) making up $32 billion per day (Figure 4). Since its inception in 2005, options on SPY have grown tremendously and are now trading at approximately $26 billion notional per day. This growth can be attributed to the popularity of S&P 500 optionality (a global benchmark for equities), combined with SPY’s minimal tracking error (as its underlying stocks are the largest U.S. companies) to the S&P 500. Within the equity-asset class, the top three volume leaders represent a diverse selection of equities with access to U.S. large- and small-cap stocks (NYSE Arca: SPY and NYSE Arca: IWM) and technology stocks (Nasdaq GM: QQQ). The remaining equity ETF options outside the top three also represent a diverse array of investments. Liquid ETF options exist within the following categories: • International equities: MSCI EEM and EAFE, Brazil, China and Mexico Figure 4 Median Notional Volume ($B) 60 50 40 30 20 10 0 Q1 ’99 Q1 ’00 Q1 ’01 Equity-Based ETF Options Median Notional Volume ($B) SPY, IWM and QQQ are the most liquid ETF options within the equities asset class. Q1 ’02 Source: BofA Merrill Lynch Global Research Q1 ’03 Q1 ’04 Q1 ’05 Q1 ’06 Q1 ’07 Q1 ’08 Q1 ’09 ■ SPY ■ IWM ■ QQQ ■ Other Q1 ’10 Q1 ’11 Q1 ’12 12 November / December 2012
Page 1 and 2: Plus Blitzer on the history of opti
Page 3: Contributors Mark Abssy Mark Abssy
Page 6 and 7: STOXX LIMITED INNOVATIVE INDEXING.
Page 8 and 9: People’s futures are in your hand
Page 10 and 11: ©2012 Morningstar, Inc. All rights
Page 14 and 15: Figure 5 Median notional Volume ($B
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Page 18 and 19: The Loch Ness Monster. Sightings of
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©2012, THE NASDAQ OMX GROUP, INC.
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