Abstract

This thesis examines the hedging effectiveness of European style S&P 100 index options (with the ticker symbol XEO) versus S&P 500 index options (with the ticker symbol SPX). SPX has more than thirty years of trading history. Launched on July 23, 2001, the XEO provides investors an alternative to hedge exposure to market fluctuations, especially in large-cap stocks. In my research, based on data from July 2001 to December 2011, I compare the hedging effectiveness of XEO and SPX options in hedging their underlying assets: the S&P 100 index and the S&P 500 index, respectively. The dynamic hedging strategy and the static hedging strategy are applied to construct the hedging portfolios. Based on different business cycles, I also divide the sample period into bull and bear sub-periods. The results indicate that hedging using the SPX outperforms that using the XEO, especially during the 2008 financial crisis period. This is likely because the lower trading volume in index options during the 2008 crisis period caused the XEO to lose liquidity and resulted in a worse hedging performance. I also find that the dynamic hedging strategy is more effective than the static hedging strategy over all periods. The option trading volume, time to maturity, and the implied volatility are also factors that influence the hedging effectiveness of the XEO and the SPX.