Updating the Triple ETF Options Landscape

A month and a half ago, in Triple ETF Options Landscape, I published a table of all the optionable triple ETFs. Lately I have received several requests to update the data from that post and I am glad to be able to do so today.

As was the case the last time around, I used data from iVolatility.com and separated the ETFs into four groups: broad index ETFs (market cap focus); sector ETFs; geography ETFs; and bond ETFs. I am also continuing my practice of color coding the ETF pairs in terms of liquidity tiers, with green being the most liquid, yellow the next most liquid, and white the least liquid.

At the time of the original post, I also included DRN and DRV, the Direxion 3x and -3x real estate ETFs, which had been launched just a couple of days earlier, on July 16^th. This time around, there are two more entries in the triple ETF stable that have seen very light trading and do not yet have options associated with them. For these reasons, I have not included in the table below the MacroShares Major Metro Up (UMM) and MacroShares Major Metro Down (DMM) ETFs, both of which are linked to triple the percentage changes in the S&P/Case-Shiller Composite-10 Home Price Index.

In terms of investor interest and adoption, during the last month and half the biggest surge in interest has been in the UPRO and SPXU S&P 500 index pair, as well as the DRN and DRV real estate index pair. I have upgraded these pairs to the green and yellow liquidity levels, respectively. The emerging markets duo of EDC and EDZ also continues to gain traction, with options volume that is now on par with the most popular of the triple ETFs.

The chart below includes data through yesterday’s close and reprises the July 17^th data for an easy comparison.

It should go without saying that these are extremely risky investment vehicles, with some peculiar characteristics. Anyone who need a good metaphor to understand just how risk triple ETFs is encouraged to check out Prediction: Triple ETFs Will Revolutionize Day Trading from November 14, 2008, when what now may seem obvious sounded then like the mutterings of a crazy man.

For related posts, readers are encouraged to check out:

• Triple ETF Options Landscape
• Using Options to Control Risk in Leveraged ETFs

[source: iVolatility]

Call Volume Spikes in SPXU

Since my ongoing discussion of SPXU seems to have generated considerable interest in the SPX pair of triple ETFs (SPXU is the -3x ETF and UPRO is the +3x ETF), I thought this morning’s surge in call activity in SPXU should be noted.

As the chart below from WhatsTrading.com shows, the 20,000+ calls traded in SPXU during the first two hours of trading suggests some large bets on the SPX are now making their way into the triple ETF options arena. This should come as no surprise, as my recent Triple ETF Options Landscape confirmed large volumes of options trading in several triple ETF pairs, including financials (FAS and FAZ), small caps (TNA and TZA), large caps (BGU and BGZ) and emerging markets (EDC and EDZ.)

Today’s big SPXU transaction was for 20,961 December 75 calls, which appear to have been transacted at the ask price, suggesting some buying interest in the -3x ETF.

Whether this transaction is a speculative play or of the hedging variety cannot be determined, but given all the issues associated with price decay due to compounding, I find it interesting that the options are five months out.

[source: WhatsTrading.com]

Disclosure: Long SPXU at time of writing.

How are SPXU and UPRO Being Traded?

Yesterday, I did my best to be provocative in Is the VIX Being Artificially Depressed by Increased Use of SPXU? One of the points I made is that SPXU could be a substitute for SPX puts (and perhaps artificially depress the VIX as a result) for those who are looking for leveraged ETFs as possible portfolio hedge. To be perfectly frank, I do not believe there will be substantial demand for SPXU (or any of the triple ETFs) as portfolio hedging vehicles, largely related to the issue of the compounding effect (see Understanding the Impact of Changing Market Exposure on Leveraged ETFs from Direxion for more details.)

In fact, when I predicted a bright future for SPXU and counterpart UPRO in The Next Big Thing? back when they launched a month ago, I envisioned three primary uses for these triple ETFs:

1. As a speculative short-term trading vehicle, with particular emphasis on day trading
2. As part of various pairs trading schemes
3. As part of the many arbitrage opportunities presented by all the large and growing family of SPX-based derivatives (futures, options, ETFs, leveraged ETFs, etc.)

While I did not envision SPXU as a viable hedging vehicle, this is largely because I was thinking in terms of a longer time frame for the hedge. If SPX puts can be utilized in increments of the one month options cycle, SPXU would be at a disadvantage trying to compete on a monthly time frame. I do believe, however, that SPXU can be a viable hedge for more than just a single trading session or an occasional two day sequence, as many have suggested. Depending on volatility levels, SPXU hedges can be left in place for up to three days with minimal risk of losses due to compounding. In my opinion, only when holding periods start to exceed four days does an SPXU hedge start to become inefficient.

With SPXU already having traded 2.3 million shares as I type this, the success of this product is now assured. While the value of SPXU as a hedging instrument pales in comparison to other possible applications, I do think SPXU can be used as an effective hedge for periods of 2-3 days at a time with an acceptable degree of compounding risk.

[source: BigCharts]

Disclosure: Long SPXU at time of writing.

Is VIX Being Artificially Depressed by Increased Use of SPXU?

The continued drop in the VIX below the 25.00 level caught a number of traders by surprise, including this writer.

If one were to study last Friday’s Forces Acting on the VIX, it would not take long to determine that with very few exceptions, the fear and uncertainty associated with the forces in the graphic have been rapidly diminishing over the course of the past few months.

One of the forces that I mentioned has received very little attention and has likely been underestimated by traders – if accounted for at all. This is the growth of hedging substitutes for the SPX. As the VIX is strongly influenced by the demand for SPX puts, it stands to reason that any substitutes for SPX puts could ‘artificially’ lower VIX levels by diverting demand to alternative hedging products. Historically, these substitutes have included futures, options and various forms of swaps. With the increased interest in ETFs and particularly leveraged ETFs, however, the menu of substitutes has increased dramatically.

During the height of the financial crisis, I documented how many investors were foregoing SPX and SPY puts in favor of options targeted specifically on the financial sector.

With the introduction of the bearish -3x Short ProShares (SPXU), a triple ETF aimed at replicating -300% of the daily move in the SPX, I believe traders have found – and embraced – an alternative to SPX options that is starting to impact the VIX.

The graphic below shows how the recent increased volume in the SPXU just happens to coincide with the decoupling of the VIX and the VXN. The same factors are undoubtedly impacting volatility term structure as well and may explain some of the recent low readings in the VIX:VXV ratio.

I am leaving the title of the graphic as a rhetorical question for the moment, as one month of data will necessarily leave us far short of any sort of statistical proof. Do not be surprised, however, if SPXU and its +3x sibling UPRO continue to generate larger interest and volume, both as a hedging tool and as a speculative play. As leveraged ETFs based on the SPX increase their market share, interest in SPX puts – and absolute levels in the VIX– may see a significant decline.

For some related posts, see:

• The Rising Popularity of XLF Options
  
• Interest in VIX Waning?

[graphic: VIXandMore]

Options Available for New S&P 500 Triple ETFs

Though they are less than two weeks old, the two new triple ETFs based on the S&P 500 index already have options available to trade. The bullish 3x ETF, Ultra ProShares (UPRO) has July options that expire one week from Friday with strikes from 60 to 95, including single dollar increments from 80 through 90. The bearish -3x Short ProShares (SPXU) has options available from 70 to 95, with all the strikes in single dollar increments.

In anticipation of a broad range of applications and the potential for some significant movement, the strikes for the December options range all the way from 30 to 140 for UPRO and from 40 to 150 for SPXU.

While both of these triple ETFs have been attracting more volume each day, neither has managed to break the million share mark yet. I anticipate that we will begin to see million share days in each of these ETFs next week and shortly thereafter, UPRO and SPXU will begin to trade in the volumes currently associated with leveraged ETF pairs such as FAS/FAZ and SSO/SDS.

As these triple ETFs are based on the same underlying as the VIX, an entire new genus of trading strategies is being hatched as I write this…

The Next Big Thing?

This morning ProShares launched two new triple ETFs. Now before you exclaim, “Enough already!” consider that the new ETFs are designed to track the daily moves of the S&P 500 index. As such, these are the first 3x and -3x ETFs that track the SPX directly. For this reason alone, the two new ETFs are can’t miss products. While these triple ETFs will have some interesting hedging applications, the fact that they have a target tracking period of one trading day, like the Direxion Daily ETFs, means they will probably become very hot in the day trading space. Don’t be surprised to see 100 million shares traded in both of these within a few months.

The official names of the new ETFs are the Ultra ProShares (UPRO) and Short ProShares (SPXU). For more information on these ETFs, check out their prospectus.