An Extreme Lack of Volatility
The siren song of volatility for options traders was clearly missing in 2012, as the lack of a crisis du jour failed to provide a reason to trade. Unlike 2011, when the US credit downgrade and earthquake in Japan resulted in elevated volatility and subsequent volume spikes, 2012 was characterized by a lack of disruptive volatility events. The VIX was range-bound for most of the year, and even though May and June saw elevated volatility (peaking at 26.7 on June 1), options traders stayed on the sidelines. Options volume reached its highest monthly level in March and May, but the subsequent declines in volatility beginning in June forestalled any meaningful trading interest (see Exhibit 2).
Exhibit 2: CBOE VIX Index: January 1, 2012 to December 31, 2012
Source: CBOE
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The Bright Spots in 2012
But not all was gloom and doom in options markets last year. A major bright spot in 2012 was the considerable uptake in weekly options volumes, which have grown to become a substantial part of the marketplace. Weekly options accounted for 12.9% of total volume in 2012, as compared to just 8.3% in 2011. An expanded list of issues with weekly expirations, more frequent expirations and increased investor interest are major factors behind the popularity of weekly options contracts. Not only are investors looking to the product as a way to more narrowly refine strategies, they are also increasingly using the weeklies as a way to gain exposure to underlying equities, especially in more actively traded securities where liquidity has risen dramatically (see Exhibit 3, next page).
Exhibit 3: Trading in Options with Weekly Expirations
(June 2010 to December 2012)
Source: TABB Group, CBOE, OCC
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Options traders also enjoyed improved market quality in 2012, as the relatively benign volatility environment contributed to an improved trading environment (as long as you were not a market maker). Average bid-ask spreads declined by 12.7% from January to December 2012, while average bid/ask sizes increased by 33% (see Exhibit 4).
Exhibit 4: Market Quality in 2012
Average Bid/Ask Spreads and Size
Source: Hanweck Associates, TABB Group
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The Outlook for 2013
Despite the options market doldrums in 2012, TABB Group believes the volume retreat is a temporary phenomenon, especially when compared to trading activity in the “abnormal” market environment of 2011. The use of US-listed options by institutional investors remains in its infancy, and their adoption will only expand in the future. Latent demand from institutional investors that are just beginning to explore the role of equity options as a part of their portfolio strategies will drive volume in 2013 and beyond.
Weekly options will continue to expand their footprint in 2013 , and the pending March launch of mini options is also expected to drive volumes into 2013, especially from smaller retail accounts that have been largely absent from the options market in recent years. After initially launching for a handful of high-priced stocks, exchanges can be expected to quickly expand the list of names in the program. Trading interest from retail accounts will attract the interest of institutional accounts, especially accounts using relative value and quantitative strategies.
[Related: “Mini Options: Big Opportunities, Bigger Challenges”]
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3 Comments to "Options Markets, Battered in 2012, Are Ready for a Comeback":
asussman
10 January 2013
Andy, How concerned are you that FINRA's announcement that they will be focused on HFT and complex products in 2013 will impede volume growth and continued innovation in options markets?
Comments (159)
Andy Nybo
10 January 2013
Adam,
I do not think FINRA’s 2013 agenda will have an inordinate impact on options market growth nor innovation. Although complex in nature, options would not fit into the “complex product” segment that FINRA seems to be targeting. If anything, options provide more powerful ways for users to manage risk exposure to the underlyings.
As far as HFT in options--Most option market makers by necessity need to use high frequency, latency sensitive strategies to compete. This automated market making accounts for roughly 47% of total volume. An additional 10% to 15% of trading comes from hedge funds and proprietary trading firms using opportunistic, latency sensitive strategies that emulate market making models. The major difference from market makers? They do not have any formal quote obligations. Although often painted as being detrimental to markets, this flow is viewed by the majority of market makers as being beneficial in options markets, even though it competes directly with their business models. This is a topic I discussed in depth with market makers as part of my research on options market making coming out later this month. Almost 75% of the firms believe there is a role for “HFT” firms in options markets. I would expect the regulators to agree.
Anonymous
10 January 2013
"Battered in 2012", yes - if our reference is 2011 volumes ; not if we look at any other year on the chart, especially so 2007 and 2008, which, to my knowledge, were rather far from being considered bad years.
(and I would take the bet this is the case for other "battered" markets)