Commentary

Jared Dillian
Traders Magazine Online News

Was it Worth It?

In this piece from 10th Man, author Jared Dillian discusses how the ETF revolution is less about ETFs and more about indexing; about how people have come to view stocks less as stocks and more as blobs of stocks.

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November 2, 2011

Buyside Prefers Indexes

By Peter Chapman

Institutions are trading more options on indexes and exchange-traded funds than on single stocks, a reversal of practices just five years ago.

Michael Khouw

That's the view of one agency broker who says the change reflects a desire on the part of money managers to hedge entire portfolios. Previously, the buyside was using options to hedge individual stock positions or mimic stock performance.

"In the last several years we've seen a pronounced evolution in the types of strategies that come across our desk," Michael Khouw, a director in the equity derivatives department at Cantor Fitzgerald & Co., said at a recent industry conference.

"Five years ago, the most common strategies were fairly stock specific. Now, probably 70 percent of the flow we see are in index and ETF products."

Five years ago, Khouw said, institutions would look to create a stock replacement strategy or "come up with an asymmetric profit and loss profile for a single name." Large mutual funds would sell calls against core stocks. Hedge funds would sell puts to establish long positions.

Today, those types of trades are in decline as money managers look to "hedge their entire books," Khouw said at this year's Security Traders Association conference in Palm Beach.

Among non-ETF index products, Ed Provost, an executive vice president with the Chicago Board Options Exchange, who was also speaking at the STA confab, noted options on the S&P 500 Index were most popular with institutions.

Indeed, trading in index options has outpaced that of single stock names this year, while trading in ETF options has skyrocketed. Through September, year-to-date volume in single stock options was up 10.5 percent. Year-to-date volume in index products was up 17 percent. Volume in ETF products was up 45 percent..

At least one broker is seizing the moment. X-Change Financial Access recently grabbed the entire index options division of rival MEB Options, more than doubling its staff of index and ETF options traders. XFA now has 18 trading and support personnel devoted to index-related products. It claims to be the largest broker of major market derivatives.

 


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