US option volumes declined in 2015, raising questions around the widely-held belief that higher volatility is a key driver of demand for the listed derivatives contracts.
A total of 4.14bn options contracts changed hands over the 13 registered US exchanges in 2015 according to the Options Clearing Corporation, a 2.8% decline from 2014 and 9% off the 2011 peak.
The latest figures cement a four-year decline for an industry that had previously enjoyed a decade of double-digit annual growth.
According to Tabb Group, US options activity has seen its compound annual growth rate fall to -2.4% since 2011. During the preceding decade, the market grew at a CAGR of 19%.
“While a lack of market turbulence was a plausible excuse for lacklustre volume growth in years past, that reasoning was not as tenable in 2015,” said Callie Bost, a Tabb analyst.
The slowdown comes despite the the CBOE’s VIX volatility index hitting a four-year high of over 40 in August – its highest level since 2011 – as global stock markets sold off on concerns surrounding China’s weakening economy.
Despite an immediate rush for protection across global equity markets as the Chinese government loosened the renminbi trading band, August’s bumper options volume – the third-highest monthly flow on record – was not enough to put the market back on a growth trajectory.
“This turbulence didn’t jump-start trading as expected and the sustained volatility couldn’t bring traders back to the market either,” said Bost.
Market share struggle
The latest figures come as a disappointment to exchanges vying for market share gains through a series of product launches and platform enhancements.
Those exchanges betting that a myriad of new products would entice reticent investors back into the market have seen little evidence that the strategy is delivering. Overall volume declines came in spite of a 5% jump in the series of products traded, according to the Tabb report.
Some bright spots were noted, however. Tabb’s Bost highlights the success of Weekly options expiries, which accounted for almost a third of daily volume through 2015.
Ultimately it was the large liquid contracts that saw the biggest gains. CBOE-listed S&P 500 options hit new records in 2015 with activity in the contracts hitting a new high for the third consecutive year as 236.5m contracts changed hands. The instruments set a new daily record on August 21 as 2.9m contracts traded.
Oil-related options also found good demand amid declining commodity prices. Trading in CBOE-listed contracts tracking the United States Oil Fund ETF more than tripled over the year.
In the bid to win market share, exchanges are extending the range of execution models that they offer through additional platform launches. BATS launched the only new options exchange of 2015 as its EDGX Options platform went live in November, operating a pro-rata allocation model that dominates the US options market. During November and December, the platform picked up just 0.14% and 0.3% of overall options activity respectively.
BATS has been one of the big market share winners of the US options landscape, picking up 9.6% overall market share in 2015 compared to just 4.8% in 2014. That jump came despite the exchange’s maker-taker model representing just 30% of US options activity.
MIAX was the other big winner, doubling its market share to over 6% in 2015 (“BATS and MIAX defy options malaise” IFR 2086).
An additional exchange is expected in February as the International Securities Exchange is seeking approval to launch its third platform, ISE Mercury, which will offer a payment-for-order-flow execution model.
Regulatory hurdles
The turbulent start to 2016 would typically raise hopes among equity derivatives traders for a jump in options volume. But in addition to concerns that the volatility and volume correlation may have broken down, an array of regulatory hurdles could put any growth on hold.
New regulations included in the Internal Revenue Code will require non-US investors top pay a 30% withholding tax on equity derivatives contracts that reference US securities. The rules, which take effect in 2017, impact US equity derivatives contracts with a delta of at least 80%.
“While this new rule will not be implemented until 2017, brokerages are already working to overhaul their back-office requirements to comply with the new tax reporting obligations,” said Tabb’s Bost.
The “Camp Proposal” drafted in 2014, which would rewrite much of the Internal Revenue Code, would require all derivatives to be marked to market, including those embedded in other financial contracts.
Retail users that currently only pay tax on their realised gains would, under new legislation, be taxed on any mark-to-market gains on options holdings on an annual basis.
Tabb also notes that current proposals for the Department of Labor‘s Fiduciary Rule would re-categorise brokerages as fiduciaries for retirement accounts, ultimately requiring them to put client interests ahead of their own.
“The rule could change brokers’ business models as they adapt to new standards and limit their ability to trade listed options,” said Bost.