While much of the recent focus on the ETF phenomenon has centered squarely on their inflows and trading growth, they are quietly becoming the epicenter of the equity options market.
ETFs now account for about 70 percent of all equity options volume, or $770 billion of the approximate $1.1 trillion traded per day, using a sample of the past 20 trading days.
The option volume of ETFs relative to stocks is effectively the reciprocal of overall equity trading where ETFs make up about 30 percent to stocks’ 70 percent, as illustrated in the two charts below.
The table below shows the most active equities and the difference between their actual trading and their options trading.
SPY is most likely sucking volume away from options on S&P 500 Index futures, which trade about $160 billion a day.
The idea of ensuring market positions using options on a fully funded security such as an ETF has what attracted some early big investors to SPY back in the 1990s.
Traders will try to arbitrage SPY’s options vs. its futures vs. the ETF itself.
Once everyone began using SPY options, trading spreads nearly disappeared and bigger fish both in the U.S. and overseas started using them as well.
Some of the biggest holders of SPY options include BlackRock, Citigroup, Goldman Sachs Group, and Citadel, according to the latest filing data on Bloomberg.
SPY-and its related option market can absorb billion-dollar trades without missing a beat.
SPY aside, ETFs as a group are also seeing increasing option volume relative to stocks because they pull in new dollars from outside the actual stock market, thanks to the asset classes they track.
The SPDR Gold Trust which also sees about $1 billion a day in options trading is pulling in action from the commodity futures market.
The iShares iBoxx $ High Yield Corporate Bond ETF has seen more than $1 billion a day in options volume over the past couple weeks, as investors search for new ways to protect their holdings of corporate bonds.
“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,” says Pravit Chintawongvanich, head-derivatives strategist at Macro Risk Advisors, referring to options tied to the Chicago Board Options Exchange’s Volatility Index.
“With the HYG options market becoming more liquid, I’d expect it to be increasingly adopted as a hedge to credit positions.” The question is how much more liquidity can ETFs drain from other markets be they stocks, commodities, or bonds before they become the only market?