Capturing the Index Effect via Options

We analyze a less-known but profound impact of additions to the S&P 500 - the impact on publicly traded options of the added company. Our analysis sheds new light into the enormous magnitude of index change related price movements in the options market, and provides insights on replicable trading strategies. In general, the changes in at-the-money call and put prices are 20 to 30 times higher than changes in the corresponding stock price. Comparison between the inter-index transfers and outside additions finds far greater index effect on options prices if the underlying stocks are introduced out of the S&P 1500 index family. 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 promotions within the S&P index family. While it is not possible to capture most of these price changes because they happen very shortly after the announcement, our study highlights replicable trading strategies with statistically significant returns. Buying at-the-money calls for stocks added to S&P 500 from outside the S&P 1500 on the day after the announcement, and selling the position on the effective date of addition yields returns of 31% on average.