Crypto may have grabbed headlines last year, but the talk on Wall Street these days is all about options.
Retail investors are flocking to options, which give the holder the right to buy or sell a security, as a relatively cheap way to bet on stocks. Institutional investors are taking advantage too, as options offer a less expensive way to limit losses in times of volatile markets.
But the pandemic’s day-trading-frenzy morphed derivatives from the realm of professional traders only into tools for sophisticated retail investors, with global options trading setting record after record and overtaking futures volumes in 2021.
Take the case of IUR Capital, an equity, derivatives and advisory firm based in London. Its assets more than tripled since early January to $100 million, with one of its biggest clients shifting exposure over from crypto.
“We’ve seen speculative money move out of crypto and into options, given all the risk around the former,” IUR managing director Gareth Ryan said by phone. “Options are not seen as being outright speculative anymore.”
Trading in options surged 478% in the past decade, dwarfing the 142% growth in futures, according to data compiled by the Futures Industry Association, an industry group. But the number of deals really started heating up after 2019, when Charles Schwab Corp. waived commissions for trading in stocks, exchange-traded funds and options.
Growth accelerated even further as exchanges around the world launched options that expire every day, and investors that had once focused on crypto turned to other markets. Almost half of the total volume of contracts tied to the S&P 500 index is now in the so-called zero-day to expiry options.
The zero-day options have lured investors at a time of growing unease, allowing them to hedge every market move from a jobs report to GDP numbers. Traders also settle their position every day, instead of carrying risk overnight.
Commodities Growth
The trend is also catching on in commodities markets, which have so far focused on shorter-term contracts, instead of zero-day options. For Tim Andriesen, head of agriculture at futures and options brokerage Marex Group, that versatility can be appealing.
“In a high time of uncertainty, it makes a lot of sense to use these options products,” he said in an interview at the Futures Industry Association event in Chicago last week.
Investors are being lured by the potential for fatter returns. IUR said its main options strategy, which entails trading options spreads of different tenors, has yielded 35% so far this year, compared with the SPDR S&P 500 ETF Trust’s 14% return. Last year, even as the ETF sank 18% on a total return basis, the strategy gained 18%.
Exchanges are also seeing the benefits. At Cboe Global Markets Inc., the world’s top options exchange, and Nasdaq, options volumes have risen more than 80% since 2019.
“We’re seeing this rising tide of liquidity and volume being an advertisement for options, where investors are comfortable getting in, knowing you can get out,” said Nasdaq’s vice president Greg Ferrari.
The speedy growth of short-dated options is a reminder of how fast markets change. James Downs, chief executive officer of Connamara Systems, draws parallels between what’s happening in the options market and the move to electronic trading — technology allowed both to happen and evolve fast.
Still, he is cautious. Shorter-dated products are popular because they offer “instant gratification,” but trading does require a certain level of knowledge.
“How you market to individuals — you need to be careful of that,” he said. “And regulators are conscious of it.”
Education is a large part of why the products have become so popular over time, exchange executives say. IUR holds free webinars on topics ranging from covered calls to butterfly strategies. The firm’s December session — the biggest of the year — often has 2,000 attendees.
The Commodity Futures Trading Commission says it’s watching closely and seeking to ensure investors are aware of the risks.
“There’s a lot of content and a lot of access, but we need to make sure, especially with options and derivatives, that the information level is as high as possible because the risk of loss is obviously severely higher given the leverage,” Chair of the CFTC Rostin Behnam said at the Security Traders Association in Washington DC on Wednesday.
At CME Group Inc., average daily volume in options grew 23% in 2022 from a year earlier, and is up 21% in 2023. Trading in the exchange’s futures contracts — a market four times bigger than options — remains flat this year.
“When I was a young man in this business, a lot of people didn’t understand a futures contract and how it worked - they were very esoteric, to say the least,” CME CEO Terry Duffy said in an interview. “As the years have evolved, people have evolved with the marketplace and they understand options much better than they ever have before.”
The growth has surprised even industry veterans who have seen the hot new thing come and go before.
“I’ve been in the derivatives business for some 20 years and I’ve never seen this amount of exponential growth so quickly,” Arianne Adams, former head of options and global client services at Cboe said in an interview at the FIA event before leaving this week.