Institutions, not individuals, driving volumes: Study

Monday, October 10, 2011 Stamford, CT USA — Concerns about new regulations did not do much to slow institutional activity in flow equity derivatives last year, but a lack of conviction on the part of equity investors kept a lid on trading volumes. While U.S. institutions entered the second half of 2011 expecting a pickup in trading volumes in the months to come, it remains to be seen how the recent market volatility will affect equity derivatives trading volumes.

More than a third of U.S. institutions participating in the Greenwich Associates 2011 North American Equity Derivatives study say they expect to increase their use of flow equity derivatives in the year ahead — including 45% of institutions expecting a pickup in options use. The vast majority of remaining institutions expect their use of flow derivatives to remain unchanged in the coming year — which includes a suite of delta one, options and other volatility products.

"The equity derivatives market can no longer be viewed in isolation from cash equities," says Greenwich Associates consultant Jay Bennett. "To the contrary, because equity derivatives products are now viewed by institutions as just another means of gaining desired exposures through an integrated equity investment process, macro trends in stock markets are increasingly defining conditions in equity derivatives markets. And for much of the past 12 months, the driving themes of global equity markets were diminished volatility and the slowdown in trading volume brought on by the lack of conviction among global investors."

Options Slowdown

From the start of the second half of 2010 to the same point in 2011, institutions active in equity derivatives cut back on their use of equity options. In 2010, 70% of U.S. institutions employed single-stock listed/look-alike options. In 2011 that share fell to 63%. Institutional use of listed/listed look-alike index options overall was essentially stable at 61¿62%.

Institutions also reduced their use of options on sector ETFs, which were employed by 43% of institutions in 2010 but a more modest 38% in 2011. The decline was even more pronounced among hedge funds, with usage falling to 51% in 2011 from 64% in 2010. The only products in this category seeing a pickup in use among all types of long only and hedge fund investors were VIX options.

Activity in futures and ETFs essentially remained level from 2010 to 2011, with institutions reporting increased usage of index futures and, to a slightly lesser extent, ETFs, which are now employed by approximately half of U.S. institutions.

Commission Payments and Trading Volumes

Last year's falloff in options usage corresponded with a modest decline in the amount of commissions paid by U.S. institutions on equity option trades, with institutional investors reporting an average annual total of $3.9 million in options commission payment for the 12 months ending May-June 2011. The typical institution in this study paid approximately $2 million in commissions for clearing and execution on futures trades last year. Notional trading volume in equity swaps averaged $1.3 billion for U.S. institutions in the 12 months ending May¿June 2011.

Any slowdown last year in the trading of options and other equity derivatives was less severe than the drop in cash equity trading commissions, which declined by roughly 12%. Looking ahead, the relatively bullish expectations for a rebound in options usage indicate that institutions are less concerned about the prospects of new regulation when it comes to their equity derivative trading practices.

"Since this is mainly an exchange-traded business already, institutions are not particularly worried about having to implement radical changes in behavior as will be required in products that have traditionally traded over the counter," says Greenwich Associates consultant John Colon.

2011 Greenwich Leaders: Flow Derivatives Equity Derivatives -- North America

Goldman Sachs and Morgan Stanley are each considered an important flow equity derivative trading relationship by 60¿62% of North American institutions active in equity derivatives. These two firms top the list of 2011 Greenwich Leaders in Flow Equity Derivatives in terms of market penetration and join Bank of America Merrill Lynch and Credit Suisse as 2011 Greenwich Quality Leaders for Flow Equity Derivatives Coverage Quality.

Firms cited as Greenwich Quality Leaders have distinguished themselves from their competitors through client quality ratings that exceed those of competitors by a statistically significant margin.

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