Fireside Friday with… T. Rowe Price’s Matt Howell

Head of derivatives and multi-asset trading solutions at T. Rowe Price, Matt Howell, sits down with The TRADE to unpack some of the key themes when it comes to equity options, swaps and index futures, including industry talking points for the year ahead, methods for leveraging transaction cost analysis (TCA), and how to achieve best execution.

How do equity options, swaps and index futures differ when it comes to achieving best execution?

When thinking about best execution in the derivative space it is critical to consider all the inputs that go into measuring the outcome for the portfolio. Unlike cash instruments, there are significantly more variables beyond the prevailing market price and in the OTC world there may not even be a readily available transparent market price to base execution off.

This means that having pre-trade transparency on funding costs, clearing fees, collateral schedules and initial margin becomes an important part in deciding what your implementation looks like as well as potentially impacting counterparty selection. When dealing with clearing and margin this data can vary significantly from one portfolio to another which can also add an additional layer of complexity for block trades.

Even where futures can appear simple, given you are dealing with a mostly lit single venue instrument, once you dig into market structure you come up against elastic supply that can transfer liquidity from the underlying market through arbitrage and a monthly or quarterly roll process that can significantly distort liquidity data.

How can TCA be best leveraged when trading equity derivatives?

I think you have to re-imagine what TCA actually means when trading equity derivatives. Before the point of trade, it has to include implementation analysis where the trading desk works with the investment team to determine the most efficient method of achieving the desired investment outcome. This can include analysis of option break-evens to help decide whether to trade options or use a delta1 instrument.

In the delta1 space, you are looking across a number of different possible expressions from fully funded cash positions, futures and total return swaps all of which have different implications for the portfolio across leverage, collateral, funding and liquidity. This analysis is a constantly moving target that requires visibility across a much wider range of data and analytics than would be used in traditional TCA.

It is entirely possible that the best price on the screen may not reflect the best holistic outcome for the portfolio and this requires a shift in mindset for traders who are used to the price on the screen driving the whole execution decision making process. There is also a post-trade piece where you continue to optimise for margin potential meaning that you make decisions to move/close or roll exposures again not necessarily fully driven by market prices. This requires an informed and empowered trading desk equipped with the best data available as close to real time as possible.

What is the outlook for equity derivatives for 2024, what are the key industry talking points?

Systematic selling of volatility at the index level continues to grow as a strategy, particularly for income enhancing ETF’s, and shows every sign of being more sustainable than short volatility strategies have been in the past. There is every sign of this systematically impacting levels of implied volatility more broadly and this could even have knock on effects as some strategies base leverage on risk models that use VIX as an input.

We also expect to see hedging strategies to get more tactical and focused than they have been historically as broad index hedges have simply not worked over a sustained time period now. This could also see some additional pick up in the utilisation of custom baskets referencing themes and/or getting much more bespoke in nature.

The phenomenon of zero-day-to-expiry (0DTE) options, which has cemented its presence in the market, is another area to watch. Its potential expansion beyond the US market underscores that growing trend towards more agile and short-term trading strategies. As these trends unfold, key industry discussions will likely revolve around adapting risk management frameworks, enhancing tactical hedging strategies, and exploring the implications of these evolving practices on market volatility and portfolio performance.