Euro, Aussie dollar, and yen the most liquid currency ETF options: Currency ETF options are the least traded among the four asset classes, with their current volumes totaling about $208 million in notional per day. The primary currency ETF options traded are on the FXE (euro), FXA (Australian dollar) and FXY (Japanese yen), which is consistent with the most highly traded currency pairs (Figure 7). Among these, the contract on FXE has been a consistent leader and is currently trading $170 million in notional per day. The majority of options flows on currencies is over the counter and on off-listed exchanges, making it harder to access for individual investors. However, ETFs on currencies provide a wider audience access to options on these most commonly traded currency pairs. Like the commodity ETF options market, currencies are also relatively new, with volumes only picking up in the last four years.
ETF Option Applications
Given the breadth of the ETF options market discussed in the prior section, traditional options strategies primarily implemented on single stocks or equity indexes can now be applied simply and efficiently at the equity sector, country or cross-asset level. In particular, we examine how ETF options allow for new opportunities within the following option applications:
- Stock replacement and leverage
- Overwriting and alpha generation
- Relative value trading
Using ETF Options To Hedge
Liquid and well-developed options markets do exist on nonequity asset classes such as commodities, fixed income and currencies. However, the accessibility and standardization of ETF options across assets offers a distinct advantage, particularly for individual investors. Investors can use ETF options to efficiently and simultaneously hedge a wide range of cross-asset views. In the following examples, we show how ETF options can hedge a rise in U.S. Treasury yields, a decline in gold prices or express a view on the euro/USD spot rate.
Example 1: Put Options On TLT To Hedge A Rise In U.S. Treasury Yields
With U.S. Treasury yields hovering at multidecade lows, there is increased speculation and concern surrounding a sharp rally in Treasury rates and an end to the 30-year Treasury bubble. Investors can expect a significant decline in Treasury bond prices in the event of a sharp rate increase. A simple way to take advantage of this decline would be to sell short shares of TLT. This would, however, require putting up margin and would expose investors to uncapped losses should Treasury yields continue their historical declines.