3 key areas to watch in options trading in 2012

Contributor: Russ Chrusciel

This blog post originally appeared on TabbFORUM.

The last several months have been crazy for financial exchanges. We had anxiously waited for the Deutsche Bourse–New York Stock Exchange deal to close—a merger that would have fundamentally changed the global exchange landscape for derivatives trading – and watched the deal get blocked by the European Commission. Now, as we eagerly anticipate the implementation of Dodd-Frank legislation and the Volcker rule in the U.S. in the coming months, we should consider how the final implementation will affect trading volumes, trading strategies and compliance needs for those engaged in derivatives trading.

One thing is certain: activity in the financial arena isn’t likely to settle down any time soon.  Within the listed options space in particular, here are three key trends worth tracking as we continue to make our way through 2012:

1. More U.S. options exchanges ARE coming.
   Even though there are already nine options exchanges up and running in the U.S. today, I expect one-two more exchanges to be up and running by year-end.  NASDAQ has stated its intent to launch a third exchange (to complement its existing PHLX and NOM options markets). A new entity, the MIAX options exchange based in Miami, plans to launch during 2012. While competition is generally a good thing in the marketplace, is there sufficient U.S. options trading activity to justify 11 exchanges? And if 11 U.S. options exchanges can be supported, what is the additional cost to trading firms, brokers, vendors and others who now have to run lines and build out additional infrastructure to these new exchanges? Each options exchange will have to serve well-defined customer niches within the industry in order to sustain ongoing business.
2. Options exchanges WILL continue to roll out new products.
   It shouldn’t come as a surprise that options exchanges need products that participants want to trade. Will the exchanges be able to create products that are reasonably easy to use and understand and that actually serve a useful trading / hedging purpose for the trader? Absolutely! The difficulty will be figuring out which new products will have long-run staying power in the options space. For example, VIX options and some ETF options have been quite successful over the past few years in terms of trading volume – some lesser-known contracts, not as much. Although they are going through approval stages right now, I am quite curious to see if either “Super-LEAP” options (contracts with 4-5 year expiration dates) or “mini-options” (contracts on high priced stocks that deliver 10 shares instead of the typical 100 shares) generate consistent trading interest across the industry. The introduction of new option contracts becomes even more important in a U.S. options market with up to 11 exchanges – as each exchange seeks to differentiate itself from its competitors.
3. Foreign options exchanges WILL draw more interest and activity.
   Foreign options exchanges like Brazil’s BM&FBOVESPA and Korea’s KRX already possess significant trading volume, so they are certainly in a position to command attention in the options industry. Since both markets are derivatives hubs in their respective regions of South America and Asia, they can more readily leverage their prior successes into the next two or three years of options trading. In many trading circles, existing volume and liquidity begets MORE volume and liquidity, so both Brazil and Korea are well positioned in that way. Lastly, given that Brazil and Korea serve accelerating regional economies in South America and Asia, these markets are primed to draw increasing options trading interest from the likes of hedgers and speculators across their own regions. Moreover, I predict each of these exchanges will reach out to and work with their neighbors (like Chile or Hong Kong) to promote additional regional strength. Since full exchange mergers are tough to accomplish these days, I also see strong, targeted partnerships taking place between selected U.S. options exchanges and some of their foreign exchange counterparts in the months ahead.

These three trends in the options markets form an interesting foundation for derivatives trading on both a national and international level. Stay tuned to see what develops.

While you’re here…

• See the latest news about Valdi Options Risk Manager.
• Learn about how you can mitigate trading risk and source new options liquidity on a global scale.

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