S&P Index Options Lose Favor as Stock Plays Pick Up

Index options . . . Who needs 'em?

Not U.S. investors. Over the past two years, trading in index options has been sliding, but in the last few months, interest in Standard & Poor 100 and S&P 500 index options has fallen off a cliff.

Volatility Index Today % Change 22.33 -5.86 Source: ILX

For years, OEX and SPX index options were the hedging product of choice for investors. If you wanted to play the market's upside, you bought OEX or SPX call options. If you were holding a group of stocks you needed to protect or wanted to make some money on the downside, you chased the puts.

Put/Call Ratio Today (Noon) Previous Close 0.37 0.38 Source: ILX

But the slide in index-option activity may illustrate how comfortable U.S. investors are with the overall market's prospects. Few are spending sleepless nights worrying about a big move in the broad U.S. stock market. Instead, they're worried about the top 10 hottest technology stocks, predictably, America Online(AOL Quote), Dell(DELL Quote), Yahoo!(YHOO Quote), Intel(INTC Quote) and Microsoft(MSFT Quote).

Investors are ignoring index options and buying options on hot stocks as if they're going out of style. On the Chicago floor, traders racked up average daily volume of over 86,000 AOL options in December. In the same month, they traded just over 69,000 OEX options.

Total volume in options rocketed up 66% to 27.8 million total; but index options grew just 2.4% to 4.3 million year-over-year for the month of December, according to Chicago Board Options Exchange statistics.

And of the index options traded, just 1.5 million were OEX, down 27% year-over-year for December.

The significance of this is debatable. "Investors are playing stocks, not the market anymore," said one institutional options trader in New York City. "S&P index orders have dried up. It's scary, the complacency we're seeing."

According to that argument, Americans don't believe they need the insurance; they simply don't want to hinder the sizzling returns on their portfolios by spending the money on options as a "hedge," in case the market turns.

Not all index options are out of favor. Lynn Howard, spokeswoman for the CBOE, pointed out that not all index options have fallen out of favor. Trading in the NDX, the Nasdaq 100 index options, is increasing.

"Individual equities got so popular that people didn't care so much about the OEX and SPX. They care about components of the indices. That's not where the action is," she adds.

And ignoring index options for individual stock options can be a losing bet. In fact, that thinking by the public has made many professional traders a fortune.

"People shouldn't just buy Cisco options because they hold Cisco. That's not a true hedge," explained Rob Sorrentino with Sorrentino Asset Management. "If your AOL and Cisco shares are going up and you want to hedge them, use index options. Let's say Cisco's doubled, and now you buy puts. But Cisco doesn't go down, so you lose the premium on the puts you bought. You want to buy something that's going to weaken, and so far, that's been the indexes."

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Some interesting option activity in Marshall & Ilsley(MI Quote), up 5 5/16 to 57 5/8, surfaced after The Business Journal of Milwaukee reported that Northwestern Mutual Life was interested in a potential purchase of the bank. NML on Friday denied the report.

M&I February 60 calls were among the most active, but the price was down 1/4 ($25) to 1 1/2 ($150).