Exchange traded derivatives have had a bumper year. Lynn Strongin Dodds looks behind the scenes at the main drivers behind the increasing volumes.
Although relative newcomers crypto and carbon derivatives dominate the financial press, it is perhaps ironic that the tried and tested options are stealing the exchange traded thunder. They are not only providing liquidity but also offering a cheaper way to mitigate risk and take advantage of those windows of opportunity.
“Volatility and the need to hedge continue to drive interest in the derivatives market overall,” said Stephen Bruel, head of Derivatives and FX at Coalition Greenwich Market Structure & Technology. “But as regulations have made OTC derivatives more expensive, investors looked to the exchange traded derivatives (ETD) markets as they want to reduce their costs to trade.”
Latest figures on volumes
Overall worldwide ETD activity is booming. The latest figures from FIA show volumes grew 24% to a record 13.96 bn contracts in August from July and a staggering 91.2% against the same month last year. Options were the standout, with global trading climbing an impressive 135% to 11.11 bn contracts in the month over 2022 with the bulk emanating from the Asia-Pacific region. By contrast, global trading of futures rose by a mere 10% to 2.85 bn contracts from the same month last year.
August was not just a one off. Looking with a longer-term lens, the FIA report revealed that volumes in the first eight months jumped 54.4% to almost 81 bn contracts compared to the same time period in 2022. However, total options volume surged by 85.7% to 61.59 bn while futures just registered a mere 0.8% increase to 19.41 bn contracts from 2022’s levels. Total open interest at the end of August was a record 1.26 bn contracts which was up 4.5% from July 2023 and 6.6% from a year ago.
As for options, these 40-year-old instruments made a comeback when central banks across the developed world changed gears and started hiking interest rates to dampen inflation. Retail investors had dominated the space, but institutional investors have jumped on the bandwagon to take an affordable bet on the markets. While turbulent market conditions were a factor, industry experts also point to electronification and the plethora of user-friendly apps.
SOFR
“Options give you a lot of flexibility and we saw a huge boost from market participants who wanted to be aligned with the new macroeconomic regime,” said Mark Rogerson, EMEA head of interest rate products at CME Group. “We are seeing SOFR options, for example, running at much higher levels than during 2019 which was a very strong year and growth is expected to continue for the rest of 2023.”
“Options give you a lot of flexibility and we saw a huge boost from market participants who wanted to be aligned with the new macroeconomic regime…We are seeing SOFR options, for example, running at much higher levels than during 2019 which was a very strong year and growth is expected to continue for the rest of 2023.” – Mark Rogerson, EMEA head of interest rate products, CME Group.
SOFR options average daily volume soared 935% to 1.8M contracts during the first half of 2023 while overall had a strong six month with a record 5.23M ADV and 649M total contracts traded. The exchange attributed the growth to a combination of volatility in the markets, new participants, and the demand for risk management tools.
Investors have also become more sophisticated in their use of so called SOFR packs and bundles due to the changing macro-economic picture, according to Rogerson. These refer to the 40 quarterly delivery months which are colour coded and grouped into ten quadruplets to simplify reference to specific contract months. They had a redesign after SOFR futures and options were launched but within the exchange, white represents the first year, red the second, green for third, blue, the fourth, gold, fifth, purple for sixth, orange for seventh, pink for eight, silver for ninth, and copper for tenth.
“Traders are becoming much more thoughtful and reflective regarding the next rate move and whether it will be up, down or unchanged,” he says. “This has resulted in a change of mindset and a move towards slightly wider and less granular strategies. The mindset is I’d rather have a generic hedge of the spread of the curve versus two specific points to ensure greater timing success.”
Zero days
Some traders, especially those on the retail front, though are willing to take more of a risk. Some believe this is the reason behind the zero day to expiry options (0TDE) boom. Over the past 18 months, they have reached new heights with August showing that 0TDEs tied to the S&P 500 accounted for half of all average daily trading volume in the complex, according to Cboe, the largest U.S. options exchange operator. Overall, since the beginning of 2023, they have accounted for 43% of average daily volume, up from 36% in 2022, and just 5% in 2016 say sources.
0DTEs can trace their roots back to 2005 when the CBOE introduced weekly options, but they took the retail market by storm during the so-called meme-stock craze in 2021 whereby investors on social media platforms and in online forums like Reddit, caused certain stocks to go viral.
Today, it is not just about speculation but also using 0TDEs to hedge every market move from an employment report to GDP and inflation numbers. One of their main attractions is that traders settle their position every day, instead of carrying risk overnight.
Exchanges including Cboe have responded to by introducing 0DTE options on its SPX and SPDR S&P 500 ETF Trust (SP) last year. This meant that investors were able to trade every day of the working week instead of three days.
“We have seen record volumes this year,” says Will Mitting, founder and CEO of Acuiti. “The US is at the forefront of these short, dated options. They are not as heavily traded in Europe currently because there is not the same diversity of participants, particularly with regards to retail flow, as in the US. In addition, they have been launched later in Europe so are only gaining traction now. However, this is changing and Eurex recently launched an OTDE that is doing very well and adding to market liquidity. Our upcoming proprietary trading Expert Network quarterly survey finds that there is strong appetite among firms to trade shorter dated options in Europe, so it is a market I expect to grow.”
Eurex introduced daily options in August that track the widely followed Euro Stoxx 50 equity index. Randolf Roth, Member of the Eurex Executive Board said, “Particularly against the backdrop of increasingly volatile markets, daily options are another innovative solution for the professional market to efficiently manage exposures in a regulated and transparent market environment.”
Some in the industry believe they may pose a threat to the market with warnings that 0DTEs could potentially trigger severe volatility under certain circumstances, according to some media outlets.
Developments in futures
While options may be front and centre, the futures markets have also seen their fair share of developments. “Although it is not yet like equities, the increase in electronification has meant that there is significant growth potential from products such as credit futures,“ said Lee Bartholomew, global head of Fixed Income and Currencies ETD Product Design at Eurex. “We are seeing an increase in demand for products that provide an interplay between listed and OTC markets. Credit futures are increasingly being used as macro products that enable clients to express directional views.”
The plan according to Bartholomew is to build, scale and launch new credit indices over the next couple of years. “The market is nascent, but I think we are at a positive juncture,” he says. “The buy side has seen margins compress, looking to products that can attract new liquidity pools and are capital efficient.”
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