The current liquidity of options on the Select Sector SPDR ETFs 3 is shown in Figure 14. Options are most liquid in energy and financials, at $291 million and $139 million, respectively, notional traded per day. Open interest on all sectors is in the billions of dollars of notional. Note that volume in technology sector ETF options is lower because the majority of interest in tech optionality is traded through options on QQQ.
ETF options on sectors offer various advantages to selling individual options on a basket of single stocks, such as:
- Depending on the names, there may be limited liquidity on the single stocks versus the ETF sector.
- There is less risk in selling upside on a sector versus a single stock in the event the investor’s view is incorrect.
If there are numerous names on which upside is to be sold, it becomes simpler from a transactional perspective to sell an option on a handful of ETFs versus a basket of single stocks.
Example 6: Iron Condor On GLD To Harvest The Richness In Options
Options generally trade rich to fair value due to an embedded risk premium that accounts for unexpected increases in the underlying security’s volatility. Therefore, selling options can be a profitable trade if the underlying does not realize the amount of volatility priced into its options. However, market participants are wary of selling uncovered option positions, particularly in down markets or in times of sharp rallies.
A less risky way to sell options is through a short iron condor strategy. A hypothetical profit and loss chart for a short iron condor strategy is shown in Figure 15. In this example, the position sells 5 percent out-of-the-money call and put options, and then buys back 10 percent out-of-the-money call and put, thereby covering the two short options positions. The trade collects an upfront premium of 3 percent of notional and has a predetermined maximum loss of 2 percent. All options positions have the same maturity.
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