The 34th Annual Options Industry Conference took place last week where representatives from exchanges, market makers, technology providers and regulators were just some of the attendees gathered in California. Hosted by the Options Clearing Corporation (OCC) and the International Securities Exchange (ISE), the conference focused on discussing communication between market participants and regulators, growth in the options industry as well as fragmentation and other current challenges the industry is facing.
The conference kicked off with a conversation between ISE’s Gary Katz and Stephen Luparello, Director, Division of Trading and Markets at the Securities and Exchange Commission (SEC).
Luparello recommended that market participants speak up more about issues impacting the markets to the SEC and Luparello referred to the notice and comment period within the rulemaking process and emphasized that when talking to Washington market participants should not “pick and choose” what challenges to discuss.
Another challenge addressed at the conference was the slow pace in which the industry is seeing growth. Exchange traded funds (ETFs), index and equity options volume has averaged about 14% growth in the past 40 years, according to Henry Schwartz, President at Trade Alert LLC who provided a State of the Union type presentation at the conference stating the growth figures from the industry are from 1.8 billion in contract volume in 2000 to 4.5 billion contracts traded in 2016.
Schwartz also explained that this growth may have opened the door for other exchanges to enter the market such as Nasdaq in 2008, BATS in 2010 and MIAX in 2012. While the current number of options exchanges has grown to 14 in 2016, while volume in ETF, index and equity options trading has only seen about 2% growth in the past 5 years.
This was discussed in detail at the exchange leadership panel with representatives from ISE, the Boston Options Exchange (BOX), Intercontinental Exchange (ICE), Nasdaq, BATS Global Markets, MIAX and the Chicago Board Options Exchange (CBOE).
Ed Boyle, CEO of BOX, believes that the industry needs to better engage the institutional side, such as hedge funds and advisors, with relevant products and market structures. Currently, these end users turn to the over-the-counter (OTC) markets rather than listed options contracts. Boyle believes that this switch in how people buy options can be achieved with more educational efforts.
To that end, the CBOE has recently invested in companies such as Tradelegs, a provider of advanced decision-support software that institutional investors can employ to optimize investment performance as well Vest Financial, an investment advisor that provides options-centric products and risk management solutions. CBOE also recently acquired LiveVol, a company that turns market data into options trading strategies. Andrew Lowenthal, Senior Vice President of Business Development at CBOE remarked that these investments were made to improve the end users experience.
CBOE also believes that bringing new products to the market will engage different participants. Recently the exchange launched FLEX options with Asian and Cliquet style settlements for insurance companies looking to hedge embedded exotic options risk.
While the industry looks for new means of growth, an area that may have swelled too large is the number of options exchanges. With 14 exchanges (and MIAX plans to launch a 15th this year), the industry experiences a lot of market fragmentation and players fighting for market share. As of publication, CBOE led the pack with 17% market share followed by Nasdaq’s PHLX with 16% and then ISE with 13%.
It is important to note that pending regulatory approval Nasdaq will acquire ISE in what is believed to be a play for more market share and, according to TradeAlert’s Schwartz, the industry will experience more exchange consolidation in the future.
Fragmentation, Auctions and Market Makers
The amount of options exchanges and its benefit or harm to the market was also discussed in a different, debate-style panel at the conference. Speakers were broken up into teams to argue the pros and cons of the issue.
One team believed that the 14 options exchanges was good for innovation and led to enhanced competition in the marketplace. They also fought that this brought stability to the markets. If one exchange experiences an emergency or had to close down, there are other venues participants can move to throughout a trading day. However, the opposing team found that the significant costs associated with connecting to various exchanges was prohibitive and that multiple venues also led to a more complex market structure.
Other hot topics in the debate included auction markets at exchanges. Auctions, which were introduced in the electronic options markets to mimic the flow of information that takes place on the trading floor, provide price discovery and best execution. However, they also inadvertently lead to less liquidity, wider spreads and a two-tiered market.
Finally, the debate also explored the decreasing number of market makers, firms which are required to provide a certain amount of liquidity at exchanges. With regulatory and technology costs making it hard to operate successfully in the current market environment, the industry has experienced a loss of liquidity and concentrates risk in fewer hands. It was concluded that the industry needs to find incentives for these types of firms and help them overcome costs as well as barriers to entry.
While the options industry has their work cut out for them, educational efforts and tools that will enhance the end-user’s experience as well new, relevant products will certainly bring different players to the market. Communicating with regulators, addressing challenges with the rule makers and keeping up with the competition will also make operating in the current environment more efficient. Heavy topics were discussed at this year’s options conference but it was productive and it seems everyone knows their part in moving this space forward.