U.S. equity derivatives: Institutions hopeful, but hardly bullish

Tuesday, October 12, 2010 Stamford, CT USA — Following a slowdown in trading activity from mid-year 2009 to mid-year 2010, U.S. institutions are hopeful about a recovery in equity derivatives trading volumes in 2011, but hardly bullish.

Based on an analysis of the amount of commissions paid by U.S. institutions to brokers on trades of options, Greenwich Associates estimates average trading volume in options products declined some 20% from June 2009 to June 2010. The 187 institutions included in the research universe for the 2010 Greenwich Associates U.S. Equity Derivatives Study paid brokers a projected $715 million in execution and clearing commission on options trades over that period. At the same time, average commission payments on futures trades declined 35% to $210 million -- indicating an even more pronounced slowdown in futures trading activity.

"The U.S. equity derivatives business clearly became smaller from year to year," says Greenwich Associates consultant Jay Bennett. "After a relatively strong start to 2010, business slowed dramatically in the second quarter and has yet to bounce back due to the general lack of conviction among institutions about market direction and the resulting lack of market activity."

Looking ahead to 2011, 55% of U.S. institutions predict their use of flow equity derivatives will increase "somewhat" with another 3% predicting a significant increase. About 40% of institutions expect their use of these products to remain unchanged and only 1% expect their usage of flow products to decline. Meanwhile, nearly 80% of institutions expect their use of structured equity or securitized products to remain unchanged in 2011, with roughly 20% predicting an increase in usage. "Activity in equity derivatives market is a function of broad investor sentiment, and at the moment investors are not confident about the durability of the economic recovery or the future direction of financial markets," says Greenwich Associates consultant John Feng. "They are not confident, but they remain hopeful."

How Do U.S. Institutions Use Equity Derivatives?

Institutional investors in the United States employ equity derivatives for a variety of purposes within their investment portfolios:

  • Two-thirds of institutions use derivatives as an overlay to their active equity investment processes.
  • Almost 60% of institutions use derivatives to express directional views on individual stocks, sectors or markets. (This practice is most common among hedge funds, but is used much more rarely among insurance companies and pension funds.)
  • Almost 45% of institutions use equity derivatives as part of more complex investment strategies.
  • Only one-third of institutions use equity derivatives as an overlay to passive equity investment strategies.

Contributing to the decline in trading activity from 2009 to 2010 was a slight drop in the share of U.S. institutions employing options, futures and swaps in their investment strategies. Options are the derivative tools used most often in U.S. investment strategies, followed jointly by futures and ETFs and, at some distance, equity swaps.

Greenwich Leaders: U.S. Equity Derivatives
In the competition for trading business in "flow" equity derivatives (i.e., Delta One, Options and other Volatility Products) from U.S. institutions, Credit Suisse is cited as an important trading relationship in flow equity derivatives by a market-leading 63% of U.S. institutions. Goldman Sachs and Morgan Stanley are also named Greenwich Share Leaders for 2010. Both are named as important trading relationships by 58-60% of institutions.

Credit Suisse is also the 2010 Greenwich Quality Leader in U.S. Flow Equity Derivatives Coverage.

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