Traditional Money Managers a Hard Sell For Options

They’re too complex. They’re too risky. They’re too expensive. That’s the sentiment among traditional money managers towards options, according to brokers, hedge funds and exchange officials.

"You tend to think of these people as the most sophisticated in the world, but a huge number of them still think of options as taking on risk as opposed to managing risk," Ed Provost, an executive vice president at the Chicago Board Options Exchange, said at this year’s Options Industry Conference.

While options have been embraced by hedge funds, they have largely been shunned by traditional asset managers. A recent joint survey conducted by the Options Industry Council and Pensions & Investments Magazine found that 71 percent of pension plans, endowments and foundations do not use options.

Reasons for avoiding options include prohibitions by institutional investment charters as well as the complexity and risk associated with the derivative, according to the survey. There’s at least one other big stumbling block, according to Kevin Murphy, a managing director at Citigroup, in charge of electronic trading of options.

"It’s not just a question of expertise," Murphy said at OIC. "Some of the problem is on the operational side-the custodian side. They have these huge portfolios. To write calls against those portfolios is not a simple process to set up. They have to be able to handle those escrow receipts. It involves going back and forth with their clearing brokers."

John Rizzo

Proponents of more complex strategies face an even tougher time. Despite the devastation of their portfolios in the 2008 market rout, money managers are reluctant to tap the volatility arbitrage community for help. That’s the conclusion of one volatility trader who markets options strategies as insurance against portfolio losses.

"We’ve probably had 200 meetings with large institutional investors," Paul Britton, founder and chief executive of hedge fund Capstone Holdings Group, said at OIC. "We got two investors."

Capstone manages $1.1 billion in assets, using equities and options among other asset classes to "trade" volatility. That can involve making bets on the differences in the implied volatility of an option and the actual volatility of the option’s underlying security.

Of Capstone’s $1.1 billion, about $150 million is invested in strategies intended to show a profit when the value of a long-only portfolio declines. These can involve the use of convexity products such as VIX futures and options and variance swaps. It’s a niche business, with about $1.5 billion being managed in such strategies industry wide, Britton said .

Britton is looking to take advantage of the current fears over "tail risk," or large downward movements in an institution’s portfolio. The buzz over tail risk and black swans, or unforeseen events, has been underway since the 2008 crash, which saw the stock market drop by 21 percent in a week.

Still, despite the talk, "there’s not much happening," according to Britton. The trader, who got his start as an options market maker in the late 1980s, cites two reasons money managers decline his services: a lack of understanding of options and aversion to paying for the protection they offer.

"Nobody wants to pay for this," Britton said. "It makes no sense to me. It’s very, very frustrating." The exec advocates education for institutional investors and traders into the ins and outs of options trading.

So does Provost. For its part, the CBOE targets pension consultants, who have the ear of the defined benefit community, in its efforts to increase awareness of the risk management properties of options. The exchange operator runs an annual risk management conference, to which more pension consultants are attending, according to Provost.

Despite the hand wringing from trading execs, data supplied by the Options Clearing Corporation suggests that some sorts of institutions are having an impact. While the vast majority of options orders are for 10 or fewer contracts, over 40 percent of the volume comes from orders of 100 contracts or more, sizes most likely to be used by institutions.

At least one executive is upbeat. "We talk to more and more institutions every week," Jon Werts, a managing director at Bank of America Merrill Lynch, said at OIC.