One Area of ETFs Is Not Growing: Options

While digital currencies tend to dominate the headlines for their flashy, highly volatile price antics, many investors have turned their attention to exchange-traded funds (ETFs). Over the past several years, ETFs have grown at an astonishing pace. With well over 2,000 of these funds available to investors now, and with more launching all the time, the total assets funneled into the ETF space could reach as high as $25 trillion by 2025, according to some estimates.

For the time being, ETFs have seen years with consecutive months of inflows, while the percentage of investors owning ETFs remains low enough that analysts predict steady growth for the immediate and foreseeable future. Nonetheless, despite all of these signs that ETFs as investment vehicles are continuing to gain in dominance over other areas of investing, there is at least one area of the ETF space that has struggled. Indeed, a report by ETF Trends suggests that options on ETFs have been stagnant for many years. (For more, see: ETF Growth Spurt Will Continue.)

ETFs are typically compared to mutual funds. In doing so, investors frequently overlook one important aspect of exchange-traded funds: the ability to trade options contracts. These can be used to manage risk, to generate added income, for the purposes of speculation and even for use in resolving tax issues. However, options on ETFs seem to have stagnated in recent years.

Many investors have historically (and even up to the present day) seen ETFs as trading vehicles. In early ETFs, it was common for options to be listed, and the resulting options markets became especially robust. One need look back to the first 100 ETFs launched for evidence of this; at least 87 of those 100 funds had listed options.

This trend continued for many years, with the mid-2000s seeing a high point for options listings in ETFs. By 2006, about 75% of all ETFs listed options. However, since that time, ETF launches have begun to shift considerably. (See also: Scared by ETF Risks? Try Hedging With ETF Options.)

Beginning in the mid-2000s, the pace of ETF launches increased considerably. While in the years leading up to that time it was common for there to be anywhere from 20 to 70 ETFs launched per year, from 2006 onward, that number pushed up to 200 to 300. The large majority of the newly launched ETFs from that time onward did not offer options trading. Indeed, even as there were more ETFs being launched on an annual basis, the number of ETFs offering options trading actually dwindled from a high point in 2007.

The financial crisis helped to launch the popularity of ETFs to new heights. From 2007 to 2009, the number of total ETFs available doubled. By the end of that period, however, only half of the ETFs available offered options. By today, only about one-third of all ETFs have options available. However, as a result of the top-heavy nature of current ETF assets, nearly 9 out of 10 ETFs have options available on an asset-weighted basis.

In addition to the dwindling percentage of ETFs offering options trading, options volume has been stagnant over the past few years. Of all ETF options trading volume, 60% happens in just three popular ETFs: SPDR S&P 500 (SPY), PowerShares QQQ (QQQ) and iShares Russell 2000 (IWM). Each of these ETFs launched before 2001. Of the remaining options trading volume, a good portion happens in other ETFs that are also equally established. Overall, about 95% of all options trading volume in the ETF space for the past decade has happened in just 35 ETFs. (See also: 3 Reasons to Use ETF Options Over Futures.)

There are many possible explanations for the stagnation. The Chicago Board Options Exchange's Volatility Index (VIX), launched in 2006, provides investors with access to other ways of hedging portfolio risk. Index options and futures volumes have also climbed during that time. Generally speaking, investors have been unlikely to view new, cheap ETFs as good options vehicles. Perhaps most importantly, many of the newly launched ETFs focus on smart beta, thematic or actively managed products. Many investors view these funds not as trading vehicles but as means of gaining exposure to certain asset classes, thereby reducing the need for speculation.

It may be that the options dominance of many years ago will never return to the ETF space. In any case, as ETFs continue to evolve, there is no doubt that the industry will continue to provide investors with new tools and possibilities, regardless. (For additional reading, check out: Writing Covered Calls on ETFs.)