According to TABB Group in a new industry benchmark study released today, ‘Equity Options Trading 2008: Rising Out of Obscurity,’ “a perfect storm is about to hit the US equity options market.”
With trading levels reaching record levels on a monthly basis, volatility flirting with historical highs, a more accommodative regulatory environment and an improved understanding of the benefits of options strategies, the equity options markets are exploding, soaring to 2.8 billion contracts in 2007 – a 41% jump from 2006.
“Long perceived as a financial flea market where the nave and uninitiated speculators attempted to get rich overnight. the options market is now a sophisticated bazaar where professionals ply their trade, using refined financial techniques that can no longer be viewed or portrayed as even remotely speculative,” writes Andy Nybo, senior analyst at TABB Group and co-author with senior analyst Kevin McPartland,
Although TABB Group estimates that just 30% of institutional investors are actively using options as part of their portfolio strategies today, the markets potential provides almost limitless opportunity with the number of institutional accounts that will begin trading options doubling in the years ahead.
“Hedge funds and proprietary trading desks are developing and implementing new strategies that arbitrage incremental opportunities faster than the human mind can possibly comprehend at the same time that institutional investors are increasingly using options as part of sophisticated portfolio management activities that seek to improve, maintain and enhance their alpha-generating opportunities,” adds Nybo.
TABB Group forecasts that by 2010 over 60% of all buy-side options trades will be executed through low-touch channels. In addition, as algorithms are beginning to see rapid adoption, TABB Group says that 35% of all order flow in equity options will be trading algorithmically by 2010, promoting greater electronic trading and efficiency in the trading process.
Many of the forces that will impact the market such as penny pricing, dollar strikes, alternative execution venues, or the emergence of innovative options trading strategies, are themselves enough to shift market structure.
The 56-page study with 40 exhibits is based on conversations with 49 traders at hedge funds, asset management firms and proprietary options trading institutions, supplemented by discussions with participants at pension plan sponsors, options market-making firms, exchanges and other liquidity pools, as well as the institutional options trading desks of major broker dealers.