Money manager moves into options are spurring new trading models and technologies that market experts said will help support institutional investors' growing interest.
According to estimates from exchange executives, institutional investors now account for 50% of options trading, up from an estimated 35% five years ago. Options volumes have set one record after another since 2003, reaching 2.86 billion contracts in 2007. The trend is not abating as 1.16 billion contracts already changed hands through April this year, a 44.5% increase from the same period in 2007.
“Institutions behaved differently during the recent market downturn than during the bursting of the Nasdaq bubble. Instead of letting a chunk of their assets melt away, more managers sought to protect their portfolios by hedging with options,” Phil Gocke, managing director at the non-profit Options Industry Council, Chicago, said in an interview.
Hedge funds' explosive growth “was started by the Nasdaq bubble when a lot of former sell-side traders used their expertise in derivatives in a difficult market environment. These people know the market and want sophisticated trading solutions,” Mr. Gocke added.
Hedge funds with more than $1 billion in assets under management accounted for the bulk of institutional options trading, while 40% of traditional asset managers said they have favorably changed their attitude toward these investments, according to a February report from the Tabb Group LLC, New York. The report was based on interviews with options traders at hedge funds, asset management firms and proprietary trading groups.
To meet the rising institutional demand for options trading, exchanges and brokers are starting to adapt the same technology that has already propelled stock trading into the 21st century — algorithms, order crossing, smart routers and liquidity aggregators. The new solutions were the focus of the Options Industry's annual conference held in Las Vegas earlier this month.
“Over the past six months, I have seen significantly higher interest in trading options on the asset managers' side due to the high market volatility that managers need to hedge against. They often ask if we offer an API (application programming interface) because they want to plug their own algorithms into our trading system,” William McGowan, managing director at Interactive Brokers Group Inc., a Greenwich, Conn., firm that specializes in options, said in an interview.
“Traditional (investors) ... may not want to put options positions on their books, but they certainly deploy their capital to gain exposure to that market via funds of funds, which are very sophisticated in their handling of options trading. They want the best technology,” Mr. McGowan said, adding that some clients want their servers in the same location as their brokers to reduce the time required to access servers handling orders on exchanges.
Another factor pushing the adoption of the latest technology is the Securities and Exchange Commission's ongoing pilot program to quote options in pennies instead of five- or 10-cent increments. This has already led to an explosion of data across the seven U.S. options exchanges, including the Nasdaq Options Market, launched on March 31.