Spiders finally trap options

Options on Standard & Poor’s Depository Receipts (SPDR) – so called ‘spider’ options – last month finally broke free of the legal web that slowed their appearance on the market. Investors have been anxiously awaiting the launch of SPDR options, which may pose a threat to the Chicago Board Options Exchange’s (CBOE) S&P index option products (SPX), for which the CBOE retains exclusive trading rights.

The options are derived from the underlying SPDR, the world’s largest exchange-traded fund (ETF) in terms of size, with about $52 billion in assets as of January 2005. SPDRs seek to offer investment results that track the price and yield performance of the S&P 500 index. Before SPDR options, the only options on the S&P 500 products were the CBOE’s S&P index options products. Now that an alternative exists to the CBOE’s options, sceptics question the longevity of the CBOE’s monopoly on S&P products.

The introduction of the SPDR options follows years of speculation regarding their delay and a recent licensing dispute between the McGraw-Hill Companies’ Standard & Poor’s division (S&P), the International Securities Exchange (ISE) and the Options Clearing Corporation (OCC).

On January 6, S&P was granted a temporary restraining order preventing the ISE from listing SPDR options without a licence from S&P. The order followed a January 3 meeting between the ISE and S&P. During the meeting, the ISE “informed S&P that it was prepared to attempt to list and trade SPDR options imminently, on an unlicensed basis, with no compensation to S&P for the use of its intellectual property”, states the January 6 complaint submitted by McGraw-Hill to the Southern District Court of New York. The OCC was named in the complaint as it offered to clear transactions for the contract.

On the first day of trading, January 10, a total of 240,866 option contracts traded on SPDRs on six options exchanges, according to the OCC. The Boston Options Exchange captured the majority of the trading, with a 30% market share and 71,971 contracts traded, while the ISE traded 25,923 contracts, 11% of overall trading. Since the January launch of SPDR options through the end of trading on January 25, a total of 2,944,970 contracts have traded, according to the OCC.

Competitive threat

It will be easier to push smaller institutions or institutions with limited hedging needs towards SPDR options – given they have a smaller contract size than the SPX option, says David Hamilton, an equity derivatives trader at BNP Paribas in New York. And if a company or individual wants to hedge against the SPDR (the underlying fund) it would obviously make more sense – given the size difference – to hedge with the SPDR option.

But so far the introduction of the SPDR options has not affected SPX volumes at the CBOE, says William Brodsky, CBOE chairman and chief executive. “It is too soon to tell what impact SPDRs will have on SPX,” he adds. SPX has an established place in the market and a solid customer base that will be difficult to dent. “The SPX franchise is dominant, well in place – you can make a strong case that it is the most liquid contract index in the world, and to break into that will take time,” says Hamilton.

The CBOE is also benefiting from the launch of SPDR options that are trading on the exchange. The CBOE has traded the highest volumes of SPDR options, commanding 41% of overall volume for the month of January, a total of 729,853 contracts.

SPDRs were the first ETFs, debuting on the American Stock Exchange in 1993. An ETF is a basket of securities that tracks an index but trades like a single stock.

The exchanges that licensed the option will pay a licensing fee of 10 cents per option traded for the SPDR options. The agreement by which the ISE signed a licence for the SPDR options does not affect the January 6 complaint filed by S&P. Both the ISE and the OCC declined to comment.

S&P told Risk that “volume on SPDR options has trounced any other option.”