Schaeffer’s Market Mashup: “Mini” S&P 500 Index Options

Is the "mini" trend here to stay?

Managing Editor
Dec 11, 2020 at 2:29 PM
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The volatile market environment has seen explosive growth in the options marketplace. On the latest episode of the Schaeffer's Market Mashup podcast, Patrick is joined by John Angelos, Head of North American Derivatives Sales, and Anthony Monaco, Account Coverage Director at Cboe, and Dan Powers, Vice President of Portfolio Management at Vector Wealth Management to unpack all of it. The three experts discuss how work-from-home has created huge demand for options trading (3:20), the differences between standard and mini contracts (9:55), and how Mini S&P 500 Index (XSP) options differ from other contracts (17:23). The group wraps up with a broader discussion: is the "mini" trend here to stay? (22:11).

Transcript of Schaeffer's Market Mashup Podcast: December 11, 2020

Patrick: Ladies and gentlemen, welcome back to the Schaeffer's Market Mash up hope everybody had a wonderful Thanksgiving, a socially distant Thanksgiving. Hopefully way from the in-laws or the aunts and uncles that you were kind of hoping to social distance from in the first place. Very excited for today's episode because of the work from home and the zero broker commissions that we're facing in this volatile market environment. Retail traders have become a huge piece of the order flow for the options marketplace. According to a recent E-Trade survey, Millennial, AKA myself are also twice as likely to trade options versus other market participants. So CBOE global markets offers mini VIX futures and mini S and P 500 index options, and they have plans for even more, mini options linked to its existing product suite. Today I'm joined by John Angelos, head of North American derivative sales. John, how are you? 

John Angelos: I'm doing well Patrick.

Patrick: I've also have Anthony Monaco account coverage director at CBOE. Anthony, how are we doing?

Anthony Monaco: Hi, Patrick. Good, thanks for having me.

Patrick: And last but not least, I've got Dan Powers, vice president of Portfolio Management at Vector Wealth Management, Dan what's up?

Dan Powers: Hey Patrick. Thanks for having me on the show.

Patrick: Looking forward to discussing this, the retail trading boom of 2020 with you guys and hearing how you may think these smaller drift of contracts could appeal to us. I'm going to say us because that's who I am at this point. But first gentlemen, let's start with your individual functions. Dan, you can take this first. Can you offer up a quick summary of what you do?

Dan Powers: Yeah, I'm a portfolio manager at Vector. We work with [unclear 02:03] of 1.3 billion. My main job [unclear 02:11] structured custom option trades for our clients. 

Patrick: Alright, Anthony, what about you? 

Anthony Monaco: Yeah, thanks Patrick. So my account coverage, I cover the sell side banks and the inter dealer brokers for CBOE.

Patrick: And John, what do you got?

John Angelos: Patrick you mentioned I head our North America derivative sales. And what that entails is that I'm responsible for covering institutional buy-side clients 02:40  think hedge bonds, pension funds, insurance companies, asset managers, family offices, and the like, and my mandate theory is to really promote CBOE's proprietary [unclear 02:50] options products. And that really entails products that we either have the existing or the exclusive rights to trade in our exchange [unclear 02:58] methodology. So in that respect, there would be index options on the S and P 500, Russell, 2000 VIX options where we own the methodology there at MSEI. So I'm there promoting use cases [unclear 03:10] managers.

Patrick: Great, great. Let's jump right into it. I want to first understand overall in broader strokes, what is contributing to this explosive growth that we've seen in the options marketplace this year? John, let's just stick it with you there.

John Angelos: Sure. So, you know, I'd say that we've got to go back a little ways to really get a running start because there were a number of contributing factors. I kind of look at this in a two phases. So we back to 2007 to 2009, the global financial crisis. What we really saw at that point in time was a market leading into that that was extremely complacent. When we look at nine 11, the fed arguably kept rates too low for too long, the market was on a steady grind higher. So in many instances market participants really didn't feel a need to insure their portfolios, right. There was a cost to insurance and in many instances; our products are using that capability to mitigate risk. So the market really didn't want to spend the money to do that. Well, lo and behold, we had a black Swan event, right, marker down 20 to 30%.

So all of a sudden that kind of changed the game. We were trading about 8 million contracts per day. And within two years that went up to 16 million contracts. So a couple of things happened right then and there, people realized there was risk in the world and number two, they educated themselves to make sure they understood how to protect their portfolios. And I think this is really one of the largest capitalists. When you look at education now it is so readily available it's virtually three. In many instances, you can go to YouTube, you can go to platforms like this, Shapers has research that they offer. So it is high quality, it's accessible and it's virtually free so we had none institutional investors become educated to the fact that they know how to now use these products to mitigate risks. So that was phase number one, phase number two, and you've already alluded to this was the Robin hood effect.

What we'd had as of late, where these retail platforms that are offering free commissions, free options commissions to trade on their platform. So I'd say that's pretty cost-effective number two, we have technology, technology that was reserved once for institutional operations. These are Wall Street traders that had sophisticated tools, platforms, execution platforms, data, and analytics that are now offered to retail clients. Same type of quality and then to overlay that you can trade these products on your phone using those down analytics so it's portable. So when you look at education and the Robin Hood effect, I would say those two things combined has really opened the doors to retail participations and levels that we currently see.

Patrick: Great. First of all, thank you for the Schaeffer's shout out. I think I've been doing these podcasts for about six months and you are the first person to shout us out individually. So gold star for you as a part of this current market environment is the work from home phenomenon. How has that impacted the overall demand for options usage from retail traders in particular?

John Angelos: Yeah, that's a great question. So, as I just mentioned everything to this point, it's really been a foundational building block. The work from home has really kind of gotten us across that finish line. So when you look at what has transpired with work from home, we now have people working from home, right? So either they're employed and they have a little bit more time on their hands, that they can multitask and trade from home. Or they're at home, but they're not working, which means they even have more free time on their hands. And to back into, add onto that if they're not working and they could be using options to generate income, right? So this could be a great supplement to that. Additionally, we know that human beings love to be entertained. And when you look at options, it really provides that type of entertainment, right?

I'm going to be involved in the markets. I'm going to be, you know look at this almost as a game. Making sure that I well-read understanding of what's going on in the world and how to position myself to monetize these types of trends. So just a look at what I said transpired since 2007, options volumes went from eight to 16 million almost overnight. Last year, our average daily volume was 28.6 million contracts. And this year in September, we actually had a record month in trade just under 32 million contracts. So that truly is a Testament to the work at home environment.

Patrick: Interesting. I mean, those are video game numbers, as they say, what has CBOE done in particular to attempt to meet this demand that we've seen from the retail community?

John Angelos: Yeah, that's a good question. You know, it's something that we most certainly don't want to overlook and we want to provide service to this growing community and more important community. But as I've mentioned before, options have primarily been used at the onset by very sophisticated investors and to mitigate risk. So when you look at our proprietary index options products, they're chunky, there are a large notional value that you get for every contract that you trade. Specifically when we look at the options on the S&P 500, the largest economic indicator and followed economic indicator in the world, right? It expresses the health and wellbeing of the US economy. If you were to trade one contract on the S&P 500, that would equate to almost 370,000 notional value of a diversified portfolio of stocks. 

You know, that's great for professional managers that manage hundreds of millions and billions of dollars. But many retail clients, they just don't need that kind of exposure. It's more expensive to control that amount of notional value and you're putting more capital at risk. That's not real user-friendly for a lot of these smaller investments. So having said that, what we've done is we've taken that notional, and we cut it down by 10 times, one 10th, the size. So you now can get that same exposure to the US bellwether S and P 500 index by one contract. It gives you exposure to 37,000 versus $370,000.

Patrick: Right, and this isn't the first time in this space, we've discussed the mini VIX or VXM futures. And you mentioned they were one 10th, the size of standard VIX futures. I'm going to pivot over to Anthony here, correct me if I'm wrong, but you guys also offer mini S&P 500 options XSP break that down for me.

Anthony Monaco: Yes, that's correct Patrick XSP is a product we're really excited about it is the mini SPX. It is one 10th, the standard size, and it is designed to track the S&P 500 index. It could fit into portfolio a variety of ways. It can be used to gain large cap US equity exposure. It can be used to mitigate downside risk and to enhance yields in portfolios. It's a smaller, more manageable contract size that allows for greater flexibility especially for the newer index trader.

Patrick: Okay. That's a pretty effectively tweet length review.

Anthony Monaco: You know another thing to think about Patrick is it could also be a smaller piece to fit into a larger strategy as well.

Patrick: Okay. So walk me through one more time, the difference between like a standard contract besides the specific quantitative differences, but between the standard and the mini, what else is at stake here?

Anthony Monaco: You know, I think that the fishermen is just a smaller bite-sized contract and John alluded to it before less capital intensive notional, but still allows investors to navigate their portfolios the same as they would if they're using the standard. Right, and just to give you a snap shot of where it is in the market, if the SPX is at 367 XSP, which tracks that is that 366 spot seven.

Patrick: Okay, alright. Yeah, that makes sense. Dan, let's get you involved here. Why would someone, or how could someone use these XSP options especially within this current market environment or in possibly in the future when we're through this pandemic?

Dan Powers: Yeah, well, that's a good question. As I mentioned before, we managed money for retail investors, as John was saying, there's still [unclear 12:12] investors, right? They're not big financial institutions like [unclear 12:15] endowments. They also have to think about their investments on an after-tax basis. And a lot of times people think about retail investors. Now, a lot of their assets tied up in after tax accounts [unclear 12:33] trusting them. One of the benefits of using XSP options is that you get the tax at a 60% [unclear 12:43] gains weight, 40% short term capital gains rate, same thing, with the SPX contract. But it allows us to be able to structure [unclear 12:54] accounts [unclear 13:00]. One of the things that we did this year as John mentioned also that we can use options. These are risk profile of your trade.

So we have a lot of clients that after the March crap happened in the spring and the summer, they wanted to increase their equity exposure that they maybe didn't want to just jump right in and buy the S&P or a different, a mutual fund at the current price of stocks. What we did was we structured a trade as Paul [unclear 13:34] that's allowed clients to augment or change the specific payout structure of other S&P investors. [Unclear 13:46] to do this. So the trade works worked where we, all the money and we were selling put options. Generally I bought 12 months out at a time, 24 [unclear 14:00] below the market. So for these clients that we're still a little bit cautious, but wanting to get something pretty, what that does is it makes us, they [unclear 14:09] get to the market at the current price.

So you don't have to pay the buffer, or they're going to essentially do all the [unclear 14:20] market. It also brings an option premium. So you collect premium when you sell the PUT, you use that PUT [unclear 14:29] going to buy call options. What it did was it created a structure where we had a job offer, but we also then got exposure to the upside if the market would hire us for those calls. So you had participated most of the move, not the entire thing. But we know that plants were a clients like that structure a lot better than just, certain clients like their lot better than yours, rather than just getting along with the stock market.

Patrick: Okay. So with XSP, you can speculate on the direction either way, correct?

Dan Powers: Yeah, [unclear 15:09] no directional movement at all. We like to talk about how with options, you can structure a trade that's going to make money in two or three market environments. What we were selling with the [unclear 15:24] market and having just come off of with a big crash. I didn't think that the market was going to be trading [unclear 15:32] the market [unclear 15:35] or down a lot. And so for clients that were, wanting to get some anxiety drawdowns in this some anxiety [unclear 15:46] draw. Using that risk reversal is a great way to [unclear 15:53] them from both sides. 

John Angelos: If I can just add on for a second, this reminded me kind of a funny story. When I was growing up I went to grad school and I took a derivatives class. And back in the day, this was really cutting edge. And what I learned in this class was pretty remarkable, which actually got me into this business. And I remember I went to my parents and I said, you know, I've got to figure out a way to get a job trading options.

And they're like, well, why is that? I go, well, I've learned that you can make money if the market goes up, if the market goes down or if the market goes sideways. And I'm like; there aren't too many businesses that you can make money in every possible regime. And to your point about really shaping your risk reward profile, there are unlimited things that you can do from a strategy perspective with the usage of options. So it's pretty remarkable so sorry, I just had to digress there and talk about my history in derivatives.

Patrick: No, trust me I love the stories. Yeah. I mean, and it hearkens back to what John was saying about the perfect storm, really, whereas you have all this, these products that are strategy heavy, and now people with more time on their hands that are ready to utilize said strategies. I know that there are other products out there that offer exposure to the S&P 500, Anthony. You can take this one first. What is the difference between XSP and those other options out there?

Anthony Monaco: Well, I think the one that it's most commonly compared to is spine, which is the ETF that tracks the S&P 500, and I think that it's, would be prudent to highlight the difference between index options and ETF options. And, you know, but before I do that, let me just back up and say, there are some similarities between XSP and SPY options where they are both PM settled, and they both have weekly expires for those strangers that like to trade shorter maturities. But I think the difference is that we feel index options have a competitive advantage. And there's three main points that I'd like to highlight, index options are cash settled as opposed to ETF options, which are physically settled. Which could cause unwanted delivery of shares, which can add another layer of operational risk to portfolios? 

Secondly, ETF options are American style they can be exercised at any time during the life of maturity, index options are European style expiry. They can only be exercised on the day of maturity and this really protects option sellers from any outsize moves the market may experience. And also there is no difference because indices do not pay dividends and last, but certainly not least what I think is really important is the favorable tax treatment that comes along with index options. And Dan, I'm curious to hear what you have to say about if some of the decision-making process, between choosing between SPY and XSP, if some of that is fiscally motivated. 

Dan Powers: Yeah, definitely. When we're dealing with practical accounts, [unclear 19:15] I'm using index options. Now that we have the XSP mini options that, they're going to [unclear 19:22] all of our clients the European stock was also really important. A lot of times we'll structure trades that are [unclear 19:33] wants in [unclear 19:35] and having an early or mess up. So we liked the fact that [unclear 19:42].

Patrick: That's was the difference between the index options and the ETF. What about specifically, when you talk about XSP and SPY, Dan, you can take that?

Dan Powers: [Unclear 20:02]. You've got a tax advantage using XS options if your duration of trade is less than 12 months, and you've got the European future. So, you know, you don't have early assignment with your strategy involves shorting and options, potentially shortening your call. So if we're doing call spreads as part of a strategy [unclear 20:28] index options [unclear 20:32]. 

Patrick: John, Anthony do you guys have anything to add to that? 

John Angelos: Yeah. As a matter of fact, I do. And I, again, it's a pleasure to know that you understand those benefits, because I will tell you this, since I do traffic in the institutional asset manager space. I can't tell you many asset managers, literally we use SPY options and they have no understanding as to the favorable tax treatment they would get with Index options. And, you know, we're not supposed to be advising, you know, regarding tax treatment I would suggest that everybody talks to their advisors for this but it seems to be pretty well known of the benefits.

And if you're not using SPX index options and you're using SPY, you're probably leaving money on the table. And I had a conversation just recently with a hedge fund that this gentleman was using SPY. And I brought to his attention the tax treatment and he thought, I always thought that that applied to SPX. I'm like, no, it also applies to XSP, right the smaller version. He was not aware of that. So it's a very important distinction to understand, because like I said, if you're using the competitor, you're most likely leaving money on the table, just from a pure taxation standpoint.

Patrick: Yeah, that's fascinating. And ironically that if this is, you know, tailored towards our retail audience, and they're essentially getting a leg up on these hedge fund people that are almost kind of glossing over that that knowledge is almost overlooked in some areas. So I do want to close out here focusing back on the mini trend and John, you can take this first and then we'll have all three or the rest of you guys give your final thoughts. Do you think the mini trend is here to stay? And what can we expect in the next year or so?

John Angelos: Yeah, I would say it's absolutely here to stay you know, these retail investors I don't think they're going away anytime soon. Once you start trading options and you understand the utility of it, you would be doing yourself a disservice not to continue to trade them. Having said that we're most certainly going to continue to take some of our larger index options products and miniaturize that. So next stop is going to be our RUT index options [unclear 22:47] gives you exposure to the Russell 2000 and we'll probably continue to roll out you know similar product innovations in a similar fashion. So yes, it's here to stay and we're going to continue to work with our retail community to make sure that we can provide these types of products for their benefit.

Patrick: I feel like that RUT will be incredibly popular given its notoriety this year.

John Angelos: Yeah. You know, exactly I mean, up until just recently, it seems like everything was relatively highly correlated. But we're starting to see those correlations breakdown. So I think it provides a lot of really interesting trading opportunities between the, you know, US industry you know so I agree with you.

Patrick: Dan, Anthony, what do you guys got to wrap up?

Anthony Monaco: Yeah. Patrick, I'd like to jump in thank you. So we've uncovered some interesting things here at the CBOE. You know, we're always looking to get a better idea of whose trading our products. And we did some data mining we're like, alright, let's pop the hood open, let's take a look. And we've uncovered that the average option trade is six contracts, which is about half the size from a couple of years ago. And we've also determined that there are two and a half million single contract trades per day. This is about 8% of the overall volume, so up from 2%, a few years back. And, you know, I think that this just screams that the retail investor is here and they will continue to be a driving force in the market. And we are fortunate here at the CBOE to have a robust educational arm. The options Institute team has extensive product knowledge and is always well willing and able to help bring clients up the product curve.

Patrick: Dan, take us home.

Dan Powers: Yeah, Patrick I sure hope that the mini trend is here to stay. It's definitely been helpful for us or for our clients. I think one thing that's important to mention, you know, when we view, when we're doing due diligence on new products, like when we're looking at the XSP options, which were pretty early adopters for. Sometimes you probably have concerns about the liquidity in the options and from our standpoint, when we do our due diligence. We care a lot more about the liquidity of the underlying securities, which would be the S&P 500, the most liquid financial instruments out there.

And there's many different ways of trade it and so from an option standpoint, you pull up an options chain. We, even if there's not a lot of volume or interest on a particular option for us, we care about the liquidity of the underlying security. And so you know, we just want to make sure that people understand that and know that. And we hope that people, more people take a look at it. 

Anthony Monaco: You know, Dan, that's a really important point. Patrick, do I have time to jump in.

Patrick: Yeah, let it rip. 

Anthony Monaco: Okay. So yeah, we've recently enhanced our liquidity metrics and guidelines for our market-making community. You know, this is to drive more foot traffic in the product. These are the same market makers that are quoting SPX that are quoting XSP with; you know the same risk profile and risk metrics. So I'm glad to hear that Dan has had good experience and there's been ease of getting in and out of the, of XSP. Because we've often heard the optics as some pushback as a reason for pushback from our clients.

Patrick: John, you said you had something there for a second. Do you want to chime in?

John Angelos: I did. I was just going to kind of highlight the optics as well. It's like the one thing that I've heard is when we've got customers that look at XSP and they compare it to SPY because they're the same notional. They say, well, my goodness the SPY is so much more liquid. And that's because when you look at the screens, there's a tighter market, fair enough. They don't understand that really what happens in the marketplace, even with XSP in the wider markets, on the screens, 90% of those trades trade, right at the mid. And most people don't understand that they're just lifting offers and eating bits instead of going into a market and working in order, which is more likely where the price is going to transact that. So it appears that it's not liquid, but it's unbelievably liquid, these products the suite of SPX products are arguably the most liquid index products on the face of the planet. So I would just encourage people that if you do look at the screens and you're comparing, side-by-side SPY to XSP, please don't get discouraged and think that it's a liquid because it's not, that's all that I wanted to say.

Patrick: Very well said. And yes, I'll just wrap up and say, I, you know, I feel like this perfect storm event that we've talked about with the pandemic has opened up all these different avenues for that, I thank you guys. John Angelos, Anthony Monaco, Dan Powers, all three of you guys, thanks for coming on, stay safe. And maybe we can chat in the future about the direction of mini and micro contracts down the road. 

Anthony Monaco: Thank you, Patrick. I appreciate it. 

John Angelos: It's been a pleasure, cheers.


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