Exchanges Explore Exotics

Terry Flanagan

Quest for new products has options exchanges looking to branch out to OTC-type listings.

Over-the-counter exotic options can be highly structured and sport more imaginative names than their listed counterparts, ranging from Rainbows to Cliquets, Bermudans and Barriers. Participants in the listed options market may soon be using such nomenclature, as the regulatory push to move OTC securities from the realm of one-off transactions to transparent trading venues has created an opportunity for exchanges to add business.

Barrier options typically activate or are extinguished when the price of the underlying asset crosses a specified level, and they tend to cost less than standard options that are more likely to pay off. As with any other security, obscurity can be shed and liquidity can be built for barrier options one investor at a time.

“They probably don’t fit our clients’ needs currently, but that could change if the market becomes more liquid,” said Jack Hansen, principal and chief investment officer of Minneapolis-based The Clifton Group, which manages more than $30 billion and specializes in derivatives.

That appears to be what some major options exchange companies are working on. Steven Crutchfield, chief executive of NYSE Amex Options, said the exchange is in the “early to middle stages” of developing products that may launch this year, noting that barrier-type options fall into that camp.

“We’re absolutely interested in making new types of options available in the listed market, and certainly the more exotic types of options than the plain-vanilla calls and puts we offer today are very much on everyone’s radar as a way to win business,” Crutchfield said, declining to provide more detail.

A Nasdaq OMX spokesman was similarly non-specific. “We’re fleshing out more proprietary products to be launched on Nasdaq OMX PHLX that provide the flexibility and advantages of the OTC markets on a lit market,” he said.

The Chicago Board Options Exchange has long been an innovator in bringing OTC-type benefits to the listed options market, launching Flexible Exchange Options, or flex options, in 1993 and later options enabling volatility trading. Three other exchanges offer floor-traded flex options, and the CBOE launched a fully electronic platform, the C2 exchange, to trade flex options in 2010. As of March 1, CBOE extended expirations to five years from three on its popular SPXpm options, which resemble its Standard & Poor’s 500 Index options but settle in the afternoon and trade on C2.

“We’re exploring expanding the maturities of the SPX out further,” said Paul Stephens, vice president and department head of institutional and international marketing at the CBOE.

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