Options Volumes Stabilize

Terry Flanagan

While the number of options exchanges keeps climbing, options trading volume is projected to rise, which could ease an oversupply of capacity.

Average daily options volumes are projected to hit 17 million in 2013, after falling from a high of 18 million in 2011 to 16 million in 2012, according to International Securities Exchange.

Options volume for 2012 reached 4,003,871,308 contracts, a 12 percent decline from the 2011 record volume of 4,562,748,194 contracts, according to the Options Industry Council.

By the end of the year, there will be 12 U.S. options exchanges. MIAX opened in the fourth quarter of 2012, and International Securities Exchange is scheduled to open its second options exchange in the second quarter, bringing the total up to 12.

“Growth in options trading volume between has been staggering, driven by electronic trading,” said Slade Winchester, head of U.S. derivatives electronic execution sales and strategy at Citi, during a press briefing on Tuesday.

The financial crisis provided the critical test for the options industry. “2008 was the year options matured as an industry,” said Winchester. “Even though the VIX ran up to 75, there was never a liquidity gap in the marketplace.”

Chicago Board Options Exchange recently reported that options on the CBOE Volatility Index (VIX) established an all-time, single-day volume record, totaling an estimated 1,388,937 contracts. VIX options volume beat the previous record of 1,219,226 contracts traded on September 11, 2012.

CBOE Futures Exchange’s VIX futures notched their second-best day ever as 299,566 contracts changed hands on the heels of a new volume high of 302,278 contracts traded.

U.S. equity options market makers are re-examining business models due to declining volumes, stagnating volatility and rising technology expenses that have created a business environment favoring larger firms with technology capable of scaling.

“Structural shifts in the U.S. equity options markets are forcing these firms to invest continually in technology to support the complexity of providing liquidity across a fragmented exchange landscape,” said Andy Nybo, principal and head of derivatives at Tabb Group, in a report.

Large market-making firms spend an average of $28.8 million annually on technology to support options market making, while small firms spend an average $2.9 million, according to Tabb Group.

Adding to the pressure is competition from high-frequency trading firms that is forcing market makers to invest significant resources in IT systems to support ever faster trading protocols. As a result, Nybo said, market makers plan to utilize automated, high-frequency trading systems for 94% of their total activity in 2013.

Options exchanges are implementing complicated pricing structures in order to attract order flow. Exchanges have complex order books, auctions, maker-taker pricing, all designed to incent order routers to direct order flow to them.

U.S. pensions are focusing on risk management, with the goal of “changing asset allocation to match liability duration and reduce portfolio volatility,” said Nathalie Texier-Guillot, head of U.S. equity derivatives structured sales at Citi.

Corporate pension plans have been particularly active in their risk management as they are looking to transfer their pension obligations to a third party. “In 2012, we saw 2 landmark transactions between U.S. corporate pension plans and insurance companies that have changed the landscape for risk transfer,” said Texier-Guillot.

Public pensions are also focused on internalization of asset management. “Following the poor performance of external managers, pensions are looking to bring asset management back in-house,” said Texier-Guillot. “They are building up large internal investment teams for both strategic and tactical asset allocation.”

This is being coupled with an externalization of risk, including the transfer of liabilities from pensions to insurers. In 2012, Verizon transferred $7.5 billion of pension obligations to Prudential, noted Texier.

Market makers see potential growth opportunities, identifying exchange complex order books (COBs), weekly options and volatility products as new areas for expansion, according to Nybo of Tabb. These firms are particularly bullish on exchange COBs, with the proportion of their volume executed in these exchange facilities set to increase to 22% of total activity in 2013.

Complex orders combining stock and options legs may be executed automatically on CBOE after being exposed to a brief auction for possibility of price improvement. The option leg will print on CBOE and the stock leg will print on the CBOE Stock Exchange (CBSX).

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