While equities volumes are in decline, options are up, says a new report by financial markets consultancy TABB Group, which claims that US investment institutions are increasingly attracted to the alpha generation potential of options.
Beginning in early 2010, the report notes a divergence of volumes that it attributes to a combination of increased volatility, saturation in the equities market and the attractiveness of options products to investors seeking to diversify their trading activity. US listed options volumes, for example, have grown at a compound annual growth rate of 20% since 2002. In contrast, several brokers have introduced cost-cutting measures in the past 12 months to deal with low equity trading volumes.
Options volumes have thrived on increased levels of volatility during H1 2011, which reached a notable peak in August as fears on US and euro-zone government debt were transmitted across markets globally. The Chicago Board Options Exchange Volatility Index (VIX), which measures prices for options on the S&P 500 stock index, climbed from 15.46 on 14 January to 29.4 on 16 March. TABB research analyst Henry Chien identifies this as the end of the equity market rally that began in March 2009.
Given the ongoing debt situation in Europe and fears over a possible double-dip recession in the US, TABB estimates that market volatility is likely to continue for some time – a scenario that is likely to fuel the further growth of options trading. “Expect options trading volumes to end the year strong with a 15% growth from 2010,” states the report.
At the same time, traditional asset managers have been expanding their range of strategies to include spread strategies, with funds now seeking to leverage options mispricing. “Funds are viewing options as not only a vehicle for managing risk but also as a source of alpha,” states the report, adding that the rise of short-term weekly expiration option contracts has helped make these strategies more accessible to a wider range of investors.
TABB's analysis also reveals that market makers have increased their participation in the options market. In August 2011, market makers accounted for 47% of all options trading compared with 44% last year. While improved trading technology and lowered transaction costs have made it easier for market making and proprietary firms to target options market inefficiencies, the growth of liquidity in the options market has also increased opportunities for low-latency arbitrage. Together these factors have further contributed to growth in options trading volumes.