Options See Higher 'Index Effect' than Share Price

June 16, 2008 (PLANSPONSOR.com) - Changes in at-the-money options prices for companies being added to the S&P 500 are 20 to 30 times higher than changes in the corresponding stock price.

That was the conclusion of a new Standard & Poor’s Index Services research report, which indicated, according to a news release, that a company’s stock price is known to rise upon announcement of its addition to the S&P 500.

A comparison of S&P 1500 inter-index transfers (stocks moving from the S&P MidCap 400 or S&P SmallCap 600 into the S&P 500) and outside additions (issues moving into the S&P 500 for the first time) between February 2002 and December 2007 finds a far greater effect on options prices if the underlying stocks are introduced from outside the S&P 1500. Between announcement and effective dates, the median at-the-money call option rises 120% for additions from outside the S&P 1500 and 32% for additions within the S&P index family, S&P said.

“The effect of being added to the S&P 500 on stock prices has been well-researched, but the impact on stock options prices has not received much attention,” said Srikant Dash, Head of Research and Design at Standard & Poor’s and author of the report, in the news announcement. “Our research shows that while the index effect on stock prices has moderated noticeably over time, the impact on stock option prices is simply enormous.”

Standard & Poor’s research shows two executable strategies that have delivered statistically significant returns at the 5% confidence level:

  • Buying at-the-money calls for stocks added to S&P 500 from outside the S&P 1500 on the day after the announcement date, and selling the position on the effective date yields returns of 31% on average.
  • Selling at-the-money puts for stocks added to S&P 500 from inside the S&P 1500 on the day before the effective date, and selling the position on the effective date yields returns of 10% on average.

More information is available at  www.standardandpoors.com/indices .

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