In a market where stock volume is evaporating, volume in short-term options is surging.
A daily average of 309,000 contracts on the Standard & Poor’s 500 Index (SPX) that expire weekly have changed hands in the first four days of September, about 72 percent more than a year ago, according to data from CBOE Holdings Inc. The contracts made up 53 percent of all those traded on the index on Sept. 5, when the last U.S. jobs report was released.
The growing market for S&P 500 weekly contracts comes at a time when investors are seeing little volatility in the broader equity market and share trading is languishing at the lowest on record. The options are used as a tool to protect stock holdings from brief losses or price swings after economic reports or Federal Reserve meetings, according to Salil Aggarwal of Deutsche Bank Securities Inc.
“We’ve been having a lot of macro-driven and Fed-driven events where people can get ahead of them in more targeted ways,” Aggarwal, a New York-based equity derivatives strategist, said by phone.
The options, which started in October 2005, are usually listed on Thursdays and expire the following Friday.
CBOE plans to start including the contracts next month in its methodology for calculating the Chicago Board Options Exchange Volatility Index. The change is scheduled to happen on Oct. 6, according to a statement from the exchange.
Investors are using short-term options to hedge their stock holdings given that losses in the overall market have remained brief. The S&P 500 hasn’t posted a four-day drop this year, compared with an average of nine a year since March 2009, according to data compiled by Bloomberg.
The weekly options made up 29 percent of total trading in S&P 500 contracts in August and 35 percent in July, the highest level for any full month so far, according to data from CBOE.
The cost of one-week S&P 500 contracts are relatively expensive compared with options with longer expirations, according to Lawrence McMillan, president of Morristown, New Jersey-based McMillan Analysis Corp.
“We mostly use them as selling opportunities,” McMillan said in an interview. “People are usually paying a high implied volatility for these options, which in our view, is not justified.”
While trading in short-term S&P 500 options has surged, overall volume in equities is near the lowest level in six years. Trading volume on U.S. exchanges fell to 5.2 billion shares daily in August, the lowest since 2008, data compiled by Bloomberg show.
The VIX, based on the price of S&P 500 options, has dropped 6.1 percent this year to 12.88, about three points from a record low, Bloomberg data show.
Among the ten most-traded S&P 500 weekly options yesterday, eight were bearish. Puts expiring Oct. 3 with a strike price of 1,800 changed hands the most, followed by contracts expiring at the end of this month with a strike price of 1,850, according to Bloomberg data.
To Mark Shepherd, president of Derivative Strategy Consultants, the contracts are often used as short-term protection against equity losses or part of complex trades. One popular strategy is when investors sell the weekly options to finance purchases of longer-dated ones, he said in an interview from Chicago.
“People and institutions are hedging very short-term market movements,” Shepherd said by phone. “If you’re a money manager and you want to keep long-term gains or not sell your stocks, per se, one quick way to hedge could be to buy the weeklies.”