European equity derivatives: Cautious optimism

Thursday, October 7, 2010 Stamford, CT USA — Despite a modest reduction in equity derivatives trading volume from mid-year 2009 to mid-year 2010, European institutions are cautiously optimistic about the prospects for equity derivatives trading in 2011.

The results of Greenwich Associates' 2010 European Equity Derivatives Study suggest that average commission spend from trading options products declined by approximately 4% among European institutions from the first half of 2009 through the first half of 2010. A report released today also names J.P. Morgan, Deutsche Bank, SG Equity Derivatives and BNP Paribas as the 2010 Greenwich Leaders in Equity Derivatives Trading.

Crossed Fingers on Market Direction
The typical European user of equity derivatives paid $5.2 million in brokerage commissions on trades of equity options in the 12-month period ending June 2010. Based on those commission averages, Greenwich Associates projects a total spend of $1.2 billion in options commissions for the 338 institutions comprising our research universe in European equity derivatives. The typical institution paid $3.0 million in brokerage commissions on futures trades, an average that was down 12% from the previous year.

"The modest decline in options trading spend among European institutions over the past year reflects the sharp slowdown in trading activity in the second quarter of 2010 following what was widely regarded as a strong start to the year," explains Greenwich Associates consultant Jay Bennett. "The year-to-year drop in options commission flow was actually much more pronounced in the United States, where we estimate commission spend fell about 20% from 2009 to 2010."

Meanwhile, the average notional volume of trades of structured equity/securitized products executed by European institutions in the Greenwich Associates research universe increased by about 5% to $165 billion from the end of the first half of 2009 to the same period in 2010. (Note: Greenwich Associates will publish the results of its 2010 distributors' study on European Retail Structured Products in a separate report later this year.)

Asked to look ahead, approximately 55% of European institutions predict their usage of flow equity derivatives products will increase in 2011, with 31% predicting no change in activity and the remainder predicting a decline in usage. In structured equity products, institutions are more mixed in opinion about market direction for next year, with about 40% of institutions expecting to increase their usage and a comparable share expecting no change. Almost 20% of institutions expect their usage of structured equity derivative products to decrease "somewhat" (as opposed to "significantly") in 2011.

"At the moment, people are praying for a strong fourth quarter and keeping their fingers crossed for 2011," says Greenwich Associates consultant John Colon. "There's a lack of conviction among investors. They have qualms about the strength of the economic recovery and the Euro. There's a lot of cash on the sidelines, which means less money going into equity markets which means less activity in equity derivatives markets. But European institutions remain hopeful."

How Do European Institutions Use Equity Derivatives?
Institutional investors in Europe employ equity derivatives for a variety of purposes within their investment portfolios:

  • Three-quarters of institutions use derivatives as an overlay to their active equity investment processes. This practice is most common among institutions in Spain and Germany; it is used much more rarely in the United Kingdom and by hedge funds across Europe.
  • Almost two-thirds of European institutions — led by investors in Switzerland and Spain — use derivatives to express directional views on individual stocks, sectors or markets.
  • Slightly more than 40% of institutions use equity derivatives as part of more complex investment strategies — a practice that is most common among hedge funds and institutions in the United Kingdom.
  • Slightly less than 40% of institutions use equity derivatives as an overlay to passive equity investment strategies.

Greenwich Leaders: European Equity Derivatives
In the competition for trading business in "flow" equity derivatives (i.e., Delta One, Options and other Volatility Products) from European institutions, J.P. Morgan and Deutsche Bank are the 2010 Greenwich Share Leaders. They are both cited as an important flow trading relationship by 51-52% of European institutions. These two firms join SG Equity Derivatives as Greenwich Quality Leaders in coverage of these products. In the trading of Securitized Equity/Securitized Products, SG Equity Derivatives and BNP Paribas are Greenwich Leaders in terms of both market penetration and quality.

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