Exchange traded funds are quickly becoming the go-to investment vehicle of choice for large institutional traders seeking to speculate on market moves or hedge portfolio positions.
ETFs make up 70% of all equity option volume, or $770 billion of the approximate $1.1 trillion traded per day, or double what the average volume was five years ago, report Eric Balchunas and Tracy Alloway for Bloomberg.
The option volume of ETFs relative to stocks is essentially a proxy of overall equity trading – ETFs make up about 30% of total equity volume, with stocks accounting for 70% of all equity volume.
Options are a type of financial derivative that represent a contract sold by a writer to a holder, allowing the buyer the right to buy or sell a security at an agreed-upon strike price before a specific date or exercise date. Call option buyers would want a security to rise while a put option buyer would want the security to fall. Options are typically utilized for speculations or bets on a market move over a specified time, or they are used to hedge a position to diminish risk of holding an asset.
The largest ETF, the SPDR S&P 500 ETF (NYSEArca: SPY), accounts for $554 billion, or almost half, of the $1.1 trillion traded each day in equity options, which cover a universe of almost 1,000 equities. While SPY makes up 13.7% of total U.S. dollar volume in equity trades, SPY is 47.6% of total options volume.
A number of factors may be attributed to the rising popularity of options trading with ETF vehicles. For instance, money managers may find it easier to insure or hedge a portfolio with ETF options – the idea of hedging a position with options on a fully funded security like SPY is what attracted many big investors early on. Speculators are also using ETF options to bet on moves.
The main factor for the rise in ETF options may have to do with the class of investors that ETFs are attracting. Specifically, some of the biggest SPY options traders include BlackRock (NYSE: BLK), Citigroup (NYSE: C), Goldman Sachs Group (NYSE: GS) and Citadel, according to Bloomberg. ETFs, like SPY, are capable of handling institutional-sized trades that can run in the billions of dollars.
“It becomes a domino effect. One investor sees a $2 billion trade, and that gives them confidence to do their large trade. These big trades bring out more liquidity,” Mohit Bajaj, director of ETF trading solutions at WallchBeth Capital, told Bloomberg.
The options activity may also help explain the relative liquid nature of junk bond ETFs, compared to the underlying primary markets. For instance, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) has seen over $1 billion a day in option volume over the past couple of weeks as investors turned to ETFs to hedge corporate debt exposure.
“Credit managers are increasingly using HYG options as a liquid hedge; previously they had used VIX calls and S&P 500 puts in part because HYG options were not as liquid,” Pravit Chintawongvanich, head derivatives strategist at Macro Risk Advisors,told Bloomberg. “With the HYG options market becoming more liquid, I’d expect it to be increasingly adopted as a hedge to credit positions.”
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.