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October 1, 2012

Casting a Wider Net

Options Industry Looks for New Sources of Order Flow

By Peter Chapman

With options volume down this year industry professionals are looking beyond traditional players such as retail investors and hedge funds for growth.

"We are strongly focused on the institutional space," Alan Grigoletto, director of education at the Options Industry Council, said at this year's joint Futures Industry Association and OIC options conference in New York. "In the coming years, we see much more participation from wealth advisers and pension funds. And even endowments." 

Alan Grigoletto

Most of the industry's volume comes from two sources: retail traders and hedge funds. Retail investors were the driving force that got the industry on its feet in the 1970s. The hedge funds have jumped in over the past 10 years.

But with volume down 13 percent through August of this year, tapping new sources of flow has taken on new urgency. During the first 8 months of this year, volume dropped to an average 16 million contracts per day from 18.5 million last year.

"The appetite is just not there," Chuck Mack, a Nasdaq OMX managing director, said at the FIA-OIC confab. "We need that appetite. We need the hungry investors to come back in."

For those looking to corral new players, there's good news and bad news. The good news is that registered investment advisers are "flocking to the options market," Jeff Chiappetta, a TD Ameritrade executive responsible for institutional trading, including advisers, told conference go-ers.

The bad news is that pension funds and mutual funds are not flocking to options, according to industry sources. Mutual funds are starting to set up hedged versions of some of their stock funds using options, but the trend is nascent. Pension plans are also tip-toeing into options, but the pace is glacial.

"The trustees on the boards of these [pension] plans come from all walks of life," Gregg Johnson, a consultant to public pension plans with Gray & Company, told conference attendees. "They range from policemen and firemen up to sophisticated investors. But when they hear the word "options" or "derivatives," they become frightened. They don't understand. They always think they add more risk to a portfolio rather than reduce it."

Johnson's firm works with public pension plans managing assets of between $100 million to $1 billion. None of them use options, he said.

The former pension actuary finds fault with the entire money management process used by public pension plans. Most trustees "miss the forest for the trees," he said. They focus too much on the minutiae of asset allocation-tracking managers and benchmarks-rather than the big picture of ensuring their future assets match their future liabilities.

Johnson contends that plan trustees should worry less about the performance of individual managers and more about the risk of the entire portfolio. The issue is one of losing money, not making it, he believes. And to that end, he views options as an essential component in a plan's investment process.