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December 1, 2004

Trading Winners and Losers As Volatility Level Hits Low

By Peter Chapman

Record lows in market volatility are driving down both buyside costs and sellside profits. The Chicago Board Options Exchange's closely watched Volatility Index, or VIX, has slid to its lowest level in eight years. The indicator, which represents the implied market volatility of a basket of widely traded options on the S&P 500 index, hit 12.75 in October. It last touched that level in 1996.

That's good news for the buyside. "Trading is less pricey when you don't see wild swings," says Marie Konstance, an executive with Plexus Group. Konstance, speaking at a roundtable on block trading, said trading costs have declined steadily.

When prices swing less, buyside traders take their time entering and exiting positions. Patient trading can produce better results. When prices swing more, traders often trade more quickly to beat a price move. Rushed trading can be more expensive, especially if broker capital is used.

"In this environment of low volatility and lowered alpha expectations, there's no sense of urgency," says Chris Heckman, an ITG managing director and roundtable participant.

The good news for the buyside is bad news for much of the sellside. Brokers who commit capital are less able to profit from price swings. New York Stock Exchange specialist, LaBranche & Co., for instance, reported a loss in the third quarter "due to continued lower equity volumes and volatility."