2016's ETFs With The Most Liquid Options

For many investors, options are an important tool for hedging. If done right, just a small position in options can help manage risk in an investor's portfolio.

Others use options as a speculative tool, buying calls and puts to bet on the direction of an individual security or market (calls increase in value when a security rises; puts increase in value when a security declines).

In either case, options provide the ability to make more sophisticated bets on markets. That's not something that's useful to everyone, but it's something that does appeal to many.

Large AUM Doesn't Mean Liquid Options

Just as with individual stocks, options are available in the ETF world. Most exchange-traded products have options available to trade, but not all of them are liquid.

A seldom-traded ETF is naturally going to have an illiquid options market, if it has one at all. On the other hand, a popular ETF will tend to have a liquid options market, but not always.

Take the iShares Core S&P Mid-Cap ETF (IJH), for example. It's the largest midcap ETF of all, with a massive $30 billion in assets. Yet its options market is tiny, with a total open interest of a paltry 2,067 contracts, according to Bloomberg data (each contract gives the owner the right to 100 shares of the underlying ETF; the right to buy in the case of calls; the right to sell in the case of puts).

The smaller, but still sizable, SPDR S&P Midcap 400 ETF Trust (MDY), with $17 billion in assets, has a much more active options market, with open interest of 100,000.

Yet it's still a stretch to call MDY's options liquid when they frequently have bid/ask spreads as wide as 15-50% or more for at-the-money contracts.

The midcap ETFs simply aren't an area where options traders are focused; thus, a vibrant options market hasn't developed there. Most of the $47 billion in IJH and MDY is likely long-term money that has little need for options trading.

Deepest Options Market

Midcaps aside, there are plenty of other exchange-traded funds with robust options markets. Unsurprisingly, the world's largest and most popular ETF in the world, the $200 billion SPDR S&P 500 ETF (SPY), is among those.

SPY is, in fact, the ETF with the deepest options market in the world. Currently, there are an incredible 24.2 million options contracts outstanding on the fund—also called open interest. Bid/ask spreads on SPY are often no more than a penny wide, minimizing transaction costs for those who want to hedge or speculate on the S&P 500.

Incidentally, SPY's options market is deeper than any individual stock, even the most widely traded, such as Apple.

First-Mover Advantage

Though nothing comes close to SPY in terms of options liquidity, there are a number of other ETFs with extremely deep options markets of their own.

At the No. 2 position is the $31 billion iShares MSCI Emerging Markets ETF (EEM), which has open interest of 9.8 million. EEM is no longer the largest emerging market ETF―that title belongs to the $42 billion Vanguard FTSE Emerging Markets ETF (VWO)―but it's the preferred emerging market fund for short-term traders.

It was also the first-to-market ETF in its segment, which is a similarity it shares with many of the other ETFs with liquid options markets.

Another ETF tied to emerging markets with an active options market is the iShares MSCI Brazil Capped ETF (EWZ). With a relatively modest $3.9 billion in assets, it's somewhat surprising to see EWZ with open interest of 3.2 million options contracts.

Similarly, the 3.5 million open interest for the United States Oil Fund (USO) is notable for a fund with only $3.2 billion in assets.

For a full list of the top 15 ETFs with the most liquid options, see the table below:

Source: Bloomberg

Contact Sumit Roy at [email protected].