Many institutional investors are planning to expand their trading in options as a way to enhance returns and moderate risk in their portfolio, according to a new research report sponsored by the Options Industry Council.
The survey conducted by consultant TowerGroup, Needham, Mass., found that 65% of 30 institutional investors were planning to expand their trading in options in the next 24 months, during what was characterized as a period “of market transition.” The investors were surveyed in April and May of this year.
“Rather than frightening institutions away from options, the financial crisis seems to have spurred them to look more closely at the potential benefits of options and other alternative instruments in enhancing returns and moderating risk in an institutional portfolio,“ said Dushyant Shahrawat, senior research director for TowerGroup in a report analyzing the data.
However, the report also found that just less than a third of the respondents did not use options because of the risks associated with the financial instrument or an institutional or cultural bias against them.
“The result suggests that non-users still associate a real or perceived threat with options,” Mr. Shahrawat said in the report.
Despite the tough investment environment, the survey results found institutional investors are generally bullish about options strategies, said Thomas Rodde, director of specialized advisory services for TowerGroup.
“The sky isn't falling despite what you read in The New York Times and The Wall Street Journal,” Mr. Rodde said. “People in a much more measured and careful way are going back to investing in alternatives.”
TowerGroup surveyed institutional investors with assets between $1 billion and $1 trillion. Mr. Rodde said most respondents had at least $5 billion in assets.
He said nearly 80% of respondents believe that options are principally a means of hedging portfolios, while 60% of respondents believe that options represent a cash-flow-neutral means of protecting a portfolio's downside (i.e., by a collar strategy of buying puts and selling calls). He said 50% of respondents indicated they believe in using options to enhance returns (i.e., via covered call writing).
However, the interest in downside protection among institutional clients is not limited to options, said Michael Thomas, chief investment officer, Russell Implementation Services, Russell Investments, Tacoma, Wash.
“We have seen strong interest in downside protection across our institutional client base, but that interest goes well beyond options to include simple derisking all the way to variance swaps,” he said.
Mr. Thomas said the credit crisis surprised institutional investors and caused them big losses. He said the investors want to be prepared next time.
“They don't care what the big surprise is, they just want to be protected,” he said.