Capacity And Liquidity
Some investors who are exploring the possibility of using index options have asked the question, Do the index options markets have the capacity and liquidity to handle large influxes of new institutional funds that will be dedicated to options-based strategies? The listed options markets now offer options on thousands of securities, and the liquidity and capacity of options markets on different securities can vary significantly. The market for options on the S&P 500 Index is the largest listed options market in the U.S. in terms of notional size. Figure 15 provides estimates for the notional value of the average daily SPX options volume, and it uses a 0.5 delta adjustment to make the figure more conservative and realistic as compared with notional value statistics that do not use any delta adjustment. The delta-adjusted notional volume estimate for the average daily volume in June 2012 was about $51 billion. The liquidity and flexibility offered by S&P 500 stocks and S&P 500 options usually have compared favorably compared with investments such as private equity. Investors should do their own due diligence and discuss with their brokers issues regarding capacity and liquidity for any security.
Since 1983, index options have been used by institutional and individual investors for a variety of purposes, including managing risk and generating income with the goal of boosting risk-adjusted returns. Since 2002, investors have had options-based benchmark indexes with which to measure the advantages and disadvantages of key options-based strategies in bullish and bearish markets.
This paper highlights some of the key features of the discussed indexes:
Total Growth. Total growth for the following indexes from June 30, 1986 through July 31, 2012 was 1,240 percent (10.46 percent annualized) for the PUT Index, 886 percent (9.2 percent annualized) for the BXM Index, 903 percent (9.2 percent annualized) for S&P 500 Index, and 390 percent (6.3 percent annualized) for the CLL Index (Figure 6).
Lower Volatility. The PUT, BXM and CLL indexes all had volatility that was about 30 percent lower than the volatility of the S&P 500 Index (Figure 8).
Left-Tail Risk. The worst monthly losses over the 26-year time period for the CLL and S&P 500 indexes were negative 8.6 percent for the CLL Index versus negative 21.5 percent for the S&P 500 Index (Figure 13).
Monthly Premium Income. The average for the gross monthly premiums collected by the BXM Index was 1.8 percent and the index options usually were richly priced (Figures 11 and 12).
Liquidity. The utilization of S&P 500 stocks and S&P 500 index options can provide liquidity and capacity for those investors who prefer flexible access to their capital (Figure 14).
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