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For many investors, options are an important tool for hedging. If done right, just a small position in options can help manage an investor's portfolio risk. Others use options as a speculative tool, buying calls and puts to bet on the direction of an individual security or market (calls increase in value when a security rises; puts increase in value when a security declines).

Puts, in particular, are in high demand today with the U.S. stock market in a bear market. By buying puts on an ETF they own, an investor can offset some of the losses they’d experience if that ETF were to decline.

However, options have a cost (called a premium), so that protection doesn’t come for free. They’re only suitable for investors who are willing to bear that cost in return for the protection that options can provide.

In any case, options provide the ability to make more sophisticated bets on markets. While it’s not something that's useful to everyone, options trading does appeal to many.

Large AUM Doesn't Mean Liquid Options

Just as with individual stocks, options are available in the ETF world. Most exchange-traded products have options available to trade, but not all of them are liquid.

A seldom-traded ETF will naturally have an illiquid options market, if it has one at all. On the other hand, a popular ETF will tend to have a liquid options market, but not always.

Take the iShares Core S&P Mid-Cap ETF (IJH), for example. It's the largest midcap ETF, with a massive $57 billion in assets. Yet its options market is tiny, with a total open interest of a paltry 8,447 contracts, according to Bloomberg data. (Each contract gives the owner the right to 100 shares of the underlying ETF, the right to buy in the case of calls and the right to sell in the case of puts.)

The smaller, but still sizable, SPDR S&P Midcap 400 ETF Trust (MDY), with $17 billion in assets, has a more active options market, with open interest of 21,498.

Yet it's still a stretch to call MDY's options liquid when compared against some other ETFs.

Midcap ETFs simply isn’t an area where options traders are focused; thus, a vibrant options market hasn't developed there. Most of the $74 billion in IJH and MDY is likely long-term money that has little need for options trading.

Deepest Options Market

Midcaps aside, there are plenty of other exchange-traded funds with robust options markets. Unsurprisingly, the world's largest and most popular ETF in the world, the $358 billion SPDR S&P 500 ETF (SPY), is among those.

SPY is, in fact, the ETF with the deepest options market in the world. Currently, there are an incredible 18.4 million options contracts outstanding on the fund—also called open interest. Bid/ask spreads on SPY options are often no more than a penny wide, minimizing transaction costs for those who want to hedge or speculate on the S&P 500.