Shrinking U.S. Options Market Lifts Costs to Hedge
By Jeff Kearns and Edgar Ortega
Feb. 5 (Bloomberg) -- The U.S. options market is shrinking for the first time in at least seven years as investors curb the use of borrowed money, making it more expensive to insure stocks against losses.
The number of outstanding calls and puts sank as much as 46 percent in January to 153 million, the lowest total in three years, according to data compiled by Options Clearing Corp. Trading slowed from a year earlier for the third consecutive month, the longest streak since May 2002, data from the Chicago- based derivatives clearinghouse show.
Investors are retreating from what was the fastest-growing U.S. securities market after more than $1 trillion in bank losses spurred the biggest swings in equity prices in 80 years. Record volatility reduced the reliability of mathematical models for pricing options and helped spur declines that shut down about 9 percent of all hedge funds last year, according to Chicago-based Hedge Fund Research Inc.
“The big firms don’t have the money or they’re not willing to commit the capital,” said Al Greenberg, the head of trading at the Chicago Board Options Exchange for BNY Convergex Group LLC. “Brokers that do a lot of institutional business are not nearly as busy, and the orders they’re getting don’t seem as large as they were a year ago.”
Fewer than 258 million contracts linked to stocks and indexes changed hands last month, down 28 percent from a year earlier, according to Options Clearing, which guarantees every transaction. Daily trading slowed 9 percent in January from the 2008 average.
Almost Threefold Surge
Open interest, or the number of calls and puts outstanding, usually falls from December to January, when all contracts with maturity dates of at least nine months expire. Still, last month was the first time since 2002 that the gauge decreased from the prior year, after growing at an annual rate of 20 percent.
Trading in options, derivatives used to protect against declines in an asset or speculate on prices, increased 30 percent a year from 2003 to 2008. Open interest climbed almost threefold.
“Everyone is just getting their house in order, and eventually all these hedge funds will say, ‘We’ve battened down the hatches and now have to make some trading profits,’” said Bud Haslett, director of option analytics at Miller Tabak & Co in New York. “The latter part of this year is going to be quite good for the options market.”
Hedge-fund assets fell by a record $600 billion in 2008 to about $1.2 trillion, according to Morgan Stanley analyst Huw van Steenis in London. Surviving funds reduced borrowing to close to nothing, according to Rasini & C., a London-based investment adviser. The plunge in stocks worldwide wiped out more than $30 trillion in market vale in 2008.
“When people lose money they don’t have money to trade,” said Randy Frederick, director of trading and derivatives at Charles Schwab & Co. in Austin, Texas. “If you look at the trillions of market cap that have come out in the last year, it stands to reason there’s less capital available for trading.”
Record High
The CBOE Volatility Index, the gauge known as the VIX that measures the cost of options on the Standard & Poor’s 500 Index, rose 2.8 percent to 45.08 at 9:43 a.m. New York time, more than double the five-year average. It exceeded 50 for the first time in October, averaged 61.18 that month and surged to a record 80.86 on Nov. 20 as the S&P 500 headed for the steepest annual loss since 1937.
The spike in volatility decreased competition as some market makers become more reluctant to trade. Interactive Brokers Group Inc., which handles 14 percent of the contracts traded worldwide, stopped making markets in options that expire more than six months in the future.
“When the VIX goes over 40 or 50, we no longer have an appetite to play this game,” Thomas Peterffy, founder of the 31- year-old Greenwich, Connecticut-based brokerage, told investors in a conference call Jan. 22. “We are much less comfortable trading and making markets in general in very high-volatility situations.”
Risk Appetite
The average difference between the best bid and offer prices for all U.S. options trades widened to 41 cents in December, the most recent month for which data are available, up from an average of 24 cents in 2007 and 35 cents last year, according to Transaction Auditing Group (TAG) Inc., a New York-based provider of market and trading-data analysis. The spread peaked last year at 56 cents in October.
“The volatility in the market is making it harder for people to pick directions and trade,” said Michael Mascitelli, a former options market maker at the American Stock Exchange who is now senior vice president of derivatives trading for New York- based brokerage Cuttone & Co. “There is less of an appetite for risk. That tends to make options a little bit more expensive.” |
