The Financial Industry Regulatory Authority today proposed an increase of position limits on several of the most traded ETF options contracts; these changes, it said, would increase liquidity and add depth to the market.
The proposal, which would double the limits on such contracts as the PowerShares QQQ Trust (QQQ) and S&P’s Depository Trust (SPY), must first be approved by the Securities and Exchange Commission.
FINRA is asking for the rule change, which would affect nine contracts, to take immediate effect if approved by the SEC, thus waiving the 30-day delay the agency typically demands. Options exchanges normally will set position limits; in fact, limits for SPY were doubled to 1.8 million after a NYSE Arca pilot program that ended in July that had eliminated position limits on that product.
The ETF options contracts affected include position limits officially increased to: 1) 1.8 million on SPY and QQQ; 2) 1 million on Russell 2000 Index (IWM) and MSCI Emerging Markets Index (EEM); and 3) 500,000 on FTSE China 50 Index (FXI), MSCI EAFE Index (EFA), MSCI Brazil 25/50 Index (EWZ), ICE U.S. Treasury 20+ Year Bond Index (TLT), MSCI Japan Index (EWJ).
SPY’s fund market capitalization in 2017 was $240.5 billion while QQQ’s was $78.8 billion.
FINRA says the broad-based indexes are unfairly subject to tighter position limits than the underlying indexes:
“FINRA believes that if certain position limits are appropriate for the options overlying the same index, or an analogue to the basket of securities that the ETF tracks, then those same economically equivalent position limits should be appropriate for the option overlying the ETF. In addition, the market capitalization of the underlying index or reference asset is large enough to absorb any price movements that may be caused by an oversized trade. Also, the issuer may look to the stocks comprising the analogous underlying index or reference asset when seeking to create additional ETF shares which are part of the creation/redemption process to address supply and demand or to mitigate the price movement of the price of the ETF.”
One example provided is with QQQ, which tracks the Nasdaq 100 Index (NDX). Options on the NDX have no position limits but “share similar trading characteristics as QQQ,” states the FINRA proposal.
Using $154.5422 as the QQQ share price, and NDX level of 6,339.14, FINRA showed where 40 contracts of QQQ equals one share of NDX. If it was assumed the position limit on the NDX was 25,000 contracts, as is the minimum under exchange rules for broad-based contracts, the equivalent would be 100,000 for QQQ.
However, there are no position limits on NDX, which has an average daily trading volume of 15,300, while options on QQQ, with the current position limit of 900,000, have an ADV of roughly 580,000 contracts. That said, the component securities of the NDX in aggregate traded 440 million shares per day in 2017, thus “both market capitalizations being large enough to absorb any price movement by a large trade in QQQ.”