Index options offers a way to capitalize on the current low interest rate environment without taking on the risks associated with single-stock options.

“There’s a bifurcation in the options market where you’re seeing more liquidity being poured into index options,” Kevin Kelly, chief investment officer and managing partner at Recon Capital Partners, a Greenwich, Conn.-based investment advisor that manages $215 million using a mix of separate accounts and ETFs. The company also acts as subadviser to the Eagle Growth & Income Opportunities Fund, where it’s responsible for management of options-writing strategy.

Most options liquidity can be found in the options on major indices such as S&P, Nasdaq and Russell. “People are going into the SPX, NDX and RUT options,” said Kelly. “That’s where you’re seeing the vast majority of liquidity. You’re also seeing weekly options are starting to account for about 30% of the overall volume.”

Asset managers who employ options strategies that revolve around the larger names, as in covered call writing, are less concerned about liquidity.

“From a single stock option perspective, we don’t have any issues at all,” said Douglas Famigletti, president and chief investment officer at Griffin Asset Management, a New York-based long-only firm that uses covered calls as a component of its investing. “We deal with very large, liquid, blue chip companies. Therefore, the options for those same stocks tend to be liquid with tight spreads. We’ve never had a problem with liquidity or with spreads with the stocks and options that we tend to trade in.”

As a covered call writer, Griffin is a seller of options, with the hope that they will expire worthless. “If I sell an option and it expires worthless, that’s fine,” said Famigletti. “The risk I run is not being able to get sufficient volume for writing new options, which I haven’t seen yet.”

He added, “We always go through these periods of short-term liquidity issues in different products, and we’ve seen it across a lot of different product categories. For my product, it’s not a gigantic concern for me because we are selling them and waiting for them to mature, hopefully worthless, or at least at a significant discount at what we sold them at and then rolling them into new options.”

The regulatory environment combined with the overall low volatility environment that the market has experienced for the last four years are among the reasons that investors are turning to index options, according to Kelly.

“Investors are turning to index options because single stock selection hasn’t been an out-performer,” he said. “We’re seeing active managers aren’t beating their benchmarks.”

Those who do use single-stock options are employing them in a more judicious manner. “When they’re going out and executing trades, they’re breaking up the trade as well as going to different providers,” Kelly said. “People are going out and talking to different liquidity providers and placing their trade in different tranches at different strikes and expiry. Market participants are going out there and shopping around, and they are able to get the liquidity provided in that manner.”

Recon Capital’s Options Management Strategy is a risk focused, absolute return, equity option strategy which targets consistent “fixed income plus” returns with volatility similar to that of a diversified bond portfolio. The strategy is designed to work as an overlay together with Recon Capital’s Global ETF Asset Allocation portfolios.

“We’re in a low interest rate environment,” Kelly said. “A lot of people are trying to hit certain targets, whether it’s 7%, 8% yield over term. Sometimes they carve out 10, 20, or even 50% of their portfolio, and then we’ll do option strategies around that collateral they provide us.”

Featured image by Olly/Dollar Photo Club