A dramatic increase in equity options trading at NYSE Euronext’s US-based NYSE Arca and NYSE Amex platforms suggests that institutional investors are increasing their use of other asset classes as they look for other ways to find returns.
The figures, which cover the 12 months to December 2011, reveal a decrease of 10.6% in average daily volume (ADV) for US equities traded across all of NYSE Euronext’s global exchanges. Yet US equity options ADV on NYSE Arca and NYSE Amex increased by 17.1% across the same period.
NYSE Euronext reported that the total ADV of global derivatives trading on all its platforms increased by 11.8% in December 2011 compared to a year earlier, with 7.5 million derivatives contracts traded, of which 3.9 million were US equity options traded on NYSE Arca and NYSE Amex. Yet US listed options have been growing at a compound annual growth rate of 20% since 2002, so the growth story is not a sudden arrival.
A key factor in this expansion is the realisation by many market participants that equity options can provide a useful hedging tool when used against equity positions, according to Andy Nybo, principal and head of derivatives research at financial research firm TABB Group.
“We have seen massive growth in US options trading over the last few years,” said Nybo. “It’s often much cheaper to use an option to gain exposure, rather than the underlying equity. Portfolio managers are starting to see this as a really cost effective way to balance their portfolios and manage their overall risk.”
At the same time, the rise of short-term weekly expiration option contracts has also contributed to making options strategies more accessible to a wider range of investors. Nybo pointed in particular to the arrival of short-term options on single stocks listed on US exchanges from June 2010 onwards as a major contributor. TABB Group recently released a research paper, ‘Accelerated Expirations: The Growing Relevance of Short-term Options’, in which it reported that short-term options accounted for 8.3% of the total 4.6 billion options contracts traded in 2011. Previous TABB reports also highlighted the increased participation of market makers in the US equity options markets as a factor in the growth of US options trading.
Meanwhile, measures contained in the Dodd-Frank Act in the US and MiFID II in Europe, both of which aim to reduce systemic risk in financial markets, have combined with increased volatility in securities markets to force a widespread increase in the importance firms place on risk management – a factor that also lends itself to an increase in options trading, suggested Nybo.
“There’s been a shift in thinking,” he said. “Risk management is getting far more important. A listed option is one of the most effective ways to manage risk, since it is cheap, flexible and well-suited to portfolio managers’ hedging needs, and many asset managers are starting to realise that. I would expect US options trading to keep growing for the foreseeable future.”
While options trading may be growing in the US, TABB Group has identified a downward trend in US equities since the beginning of 2010. The 10.6% decline in NYSE Euronext’s US cash trading figures across its NYSE, NYSE Arca and NYSE Amex venues in 2011 certainly contrasted with the rise in US equity options trading on the firm’s US platforms over the same 12 months.
Strategic Insight data reveals that the total level of US equity investment still ended Q3 2011 up by US$56 billion, suggesting it may be too early to suggest outright decline in US equities markets – but the rate of increase had slowed considerably, down from US$99.6 billion at the end of 2010. Moreover, Bloomberg data suggests investment in US equities was a thankless task last year, with close to zero return on S&P 500 investments, compared to just over 10% in 2010 and over 20% in 2009.