Still Trading SPX? Try a SPDR Instead...

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The combatants in the options wars want you to join their battle. The struggle for the hearts and minds of equity traders has never been fiercer, and the options exchanges are pulling out all the stops to lure you over to the dark side. In the past, they’ve tried to attract equity traders with the siren song of equity options. However, with margins rapidly vanishing in those products, the exchanges can no longer rely on them as their primary weapon. Instead, they are trying to tempt equity traders with the sexiest and most dangerous siren of them all – index options.

EXCLUSIVE LICENSES
While equity option margins have shrunk dramatically in recent years, index option margins have remained stable for one primary reason – lack of competition. In some cases, exclusive license agreements have rendered them the sole property of one exchange. For example, if you want to trade options on the popular S&P 500 and S&P 100 indexes, you have to go to the Chicago Board Options Exchange. The exclusivity of SPX & OEX options has been a lifesaver for the CBOE during the tumultuous options wars. But, the days of S&P exclusivity are over. A new product exploded onto the scene two years ago, and the world of index trading has never been the same.The opening salvo of this new battle was fired on January 5, 2005 when the ISE announced plans to list options on the popular SPDR ETF. Their shot was heard around the derivatives world. It echoed particularly loudly in the offices of McGraw Hill, the owners of the lucrative S&P franchise. The day after the ISE’s announcement, McGraw Hill promptly slapped them with a lawsuit. The ISE promptly saw the error of their ways and entered into a licensing agreement with McGraw Hill to list the SPDR options. However, unlike the CBOE’s license to trade the SPX & OEX, the ISE’s deal wasn’t exclusive. Four other exchanges quickly jumped onboard, eager to get a piece of the lucrative index markets. With all five of their competitors aiming to take a slice of their S&P pie, the CBOE had an unpleasant choice to make. They could either cannibalize the crown jewel of their product line or let their competitors do it for them. They chose the former.

A NEW DAWN
On the morning of January 10, 2005 the new SPDR options launched simultaneously on all six options exchanges. It was an impressive debut for a new product, trading nearly 200,000 contracts on the first day. One reason for their popularity is their flexibility and ease of use. At one-tenth the size of the full index, SPDRs are a much more user-friendly instrument than the complex and expensive S&P future. The smaller size of the underlying allows SPDR options to trade with only a dollar between strikes. That corresponds to ten-dollar strike intervals in the full index, giving traders an array of hedging opportunities that weren’t available before. The simplicity and flexibility of the new product has piqued the interest of many equity traders. “We are definitely excited about it,” says Kevin Connellan, Director of Equity Trading at Northern Trust. “We normally stay away from S& P options because they are too cumbersome and complex for most of our clients. However, options on the ETF are much more simple and straightforward.” 

While the CBOE was playing defense with the SPDRS, newer exchanges saw them as an opportunity to steal volume in the once-forbidden S&P markets. It was also a chance to show that they could go toe to toe with the other exchanges in their own game. “We see our success in the SPDRs as an example of the competitiveness of our platform,” says Ken Leibler, Chairman  of the Boston Options Exchange (BOX).” The other markets are already strong players in the index products. This was our first opportunity to jump in and compete from day one in a market where the other exchanges are already well established. “

MOVING BEYOND THE LAYOFF
As expected, the bulk of the initial SPDR option volume came from market makers looking to arbitrage their existing index positions. However, the potential of SPDR options is not limited to the professional trading market. A product with this much popular appeal can be more than just a layoff pit for SPX traders. In the two years since its launch, SPDR options have crossed over into the realm of the average investor. The idea of joe-sixpack selling SPDR calls in his IRA is no longer a far-flung notion. If you are a buyside trader who has been dreaming of new ways to hedge his portfolio, then this is the moment you have been waiting for. SPDR options have eliminated many of the difficulties that have kept equity traders away from S&P markets in the past. One of the most common hurdles was dealing with the notoriously unpredictable S&P futures market. Traders had to establish a relationship with a futures broker, then cross their fingers and hope for the best whenever they entered an order. Once they finished all of that, they still had numerous headaches to deal with. One of the most common, and deadly, headaches was the need to roll their hedge positions forward at the end of every expiration cycle.

ETF VS FUTURE
But those worries are a thing of the past. SPDR options are derived from an ETF, not a future. That means your existing trading systems are already equipped to handle them. Depending on your existing platform, you should be able to launch trades from your desk and enter them into your system with relative ease. Also, since ETFs never expire, you don’t have to worry about rolls, the bane of most index traders. If all of that still isn’t enough to pique your curiosity, then remember this. The low cost and high-name recognition of SPDR options should make them a very easy sell, even to the most demanding of clients. Time’s up. There are no more excuses. If you are serious about trading the indexes, then it’s time to get in the game."

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