There's Still No SPY "Alternative" for Options Traders

The following is a reprint of the market commentary from the February 2018 edition of The Option Advisor, published on January 26. For more information, or to subscribe to The Option Advisor -- featuring 10 new option trades each month -- visit our online store.

It was not quite a year ago in this space when we discussed the groundswell of inflows into the iShares Core S&P 500 ETF (IVV), an exchange-traded fund (ETF) that tracks the S&P 500 Index (SPX). At the time, back in February 2017, IVV was on the cusp of achieving the milestone of $100 billion in assets under management (AUM), as cost-conscious investors gravitated toward IVV's lower expense ratio relative to its S&P-tracking rival, the SPDR S&P 500 ETF Trust (SPY).

Since then, IVV's following has only grown. Over the course of 2017, IVV garnered $30.2 billion in net inflows, per etf.com, nearly tripling SPY's calendar-year net inflows of $10.6 billion. The trend is continuing so far in 2018; in the year-to-date period through Jan. 19, IVV had netted inflows of $3.4 billion -- the most of all ETFs over that time frame.

Meanwhile, SPY netted inflows of just $509 million through the first three weeks of the new year. Some significant headline ink was spilled when SPY attracted single-day inflows of $6.7 billion on Jan. 18, but this massive surge of investor interest in the "benchmark" S&P tracker served primarily to offset the impact of a $6.1 billion outflows day back on Jan. 2.

And here it's worth noting that the flows in IVV and SPY are not quite near as symmetrical as their underlying instrument. Unlike SPY, IVV's biggest day of inflows year-to-date was on Jan. 10, when $2.3 billion was added. That said, SPY's $6.7 billion windfall and IVV's $2.3 billion infusion both occurred on down days for the S&P, of which there were just three during the year-to-date period ended Jan. 19. So while the fund flows here don't line up exactly, they certainly "rhyme" a bit.

As for AUM, meanwhile, this time around it's SPY that's just blown a big round-number milestone off its hinges. SPY assets stand at $300.1 billion as of this writing, while IVV's has grown to just over half that amount, at $153.5 billion.

However, there's one area where IVV still simply does not compete with SPY -- specifically, in the realm of options. Since we last checked in on IVV, its AUM has grown by roughly 50%, driven by approximately $32 billion in net inflows... but options open interest has actually dropped by about 16% from last February's levels, to a meager 4,269 or so contracts. The top open interest strike, IVV's February 275 call, carries open interest of just 303 contracts.

The net result? Bid/ask spreads of a dollar or more on some IVV options trades, when we checked in on intraday activity earlier this week -- and trust us when we say that's some serious "slippage," of the variety that most seasoned options traders would (and should) go to great lengths to avoid.

So why hasn't IVV garnered the same type of swooning fanbase among options speculators as it has among ETF investors? There's no big mystery here -- it's most likely because that seductively low expense ratio is as meaningless to those buying option premium as it is compelling to those buying into the fund directly. And with calls and puts on SPY already among the most heavily traded and liquid in the world, there's not much motivation to go trolling through the thinly populated IVV options pits for a favorable offer.

But while there may be, for all intents and purposes, "nothing to see here" for the average option trader, we'll conclude by noting that the high-dollar inflows in IVV most certainly bear watching from a sentiment perspective. For anyone tracking equity fund flows as a measure of investor sentiment, this SPY rival can no longer be ignored.