By Mike Kentz

NEW YORK, April 13 (IFR) – Equity derivatives traders have begun to warm once again to trading over-the-counter – rather than through the regulated exchanges that many flocked to following the chaos of the financial crisis.

Volumes across listed Dow Futures, options and securities lending transactions declined by 6% in March over the previous year, following a 13% decrease in February and a 5% drop in January over 2014 levels, according to data from the Options Clearing Corporation.

The dip represents a puzzling departure from a trend of generally increasing volumes since 2009 – when concerns around counterparty credit following the collapse of Lehman Brothers pushed market participants to transact through central intermediaries in a bid to increase safety.

A host of market factors are driving equity traders back to the shade of OTC markets, not least of which is fading memories of the crisis and increased willingness to stomach counterparty credit risks.

“When clients look at the entire picture they are seeing enough of a benefit to trading OTC that they are overcoming credit fears attached to the crisis,” said Ramon Verastegui, head of engineering and strategy for the Americas at Societe Generale.

“Clients like the anonymity of OTC markets and the flexibility of bespoke solutions, and see OTC trading as reducing some exchange fees. Put as a whole, those benefits are outweighing any credit concerns and pushing clients back into OTC markets.”

The movement flies in the face of a key regulatory objective of the 2009 G20 regulatory agreement to push OTC trading activity through regulated exchanges and/or clearing houses wherever possible, in response to the Lehman collapse.

In fact, the Chicago Board Options Exchange submitted a letter to the SEC’s Division of Trading and Markets in October highlighting the market’s movement away from exchanges and requesting the SEC take action.

“CBOE is becoming increasingly concerned that the current structure of the US options markets may be promoting the use of OTC options where substantially identical standardised options are available,” wrote Ed Tilly, CEO of the exchange in the letter.

“OTC options are not subject to price discovery, price improvement and trade reporting of national securities exchanges, potentially resulting in harm to customers and market participants generally.”

Tilly requested the SEC take action to remind broker-dealers of the requirement to seek best execution for clients, and recommended the agency consider whether broker-dealers were using activity in exchange-traded options to secure better prices in the OTC market. CBOE is currently drafting a follow-up letter to the SEC.


Broker-dealers say that is not the case, and claim they have been pushed into OTC markets as a way of mitigating exorbitantly high trading fees at certain exchanges, specifically the CBOE.

The CBOE is perceived to be able to charge higher rates due to its exclusive right to list futures and options instruments referencing its own Volatility Index, an increasingly popular benchmark for tail hedging strategies in US equity markets ever since the crisis.

It has also succeeded in maintaining the exclusive right to list options on the S&P 500 and Dow Jones Industrial Average, through a 2012 lawsuit against International Securities Exchange.

While that exclusivity has led to massive gains in VIX futures and options since 2009, nowhere have the declines of the past several months been felt more than at the CBOE.

Average daily volumes for options and futures at the CBOE declined by 7% in January, 22% in February and 12% in March versus 2014 levels for each month – largely driven by drops in the exchange’s VIX futures and options contracts. (See chart.)

Participants say the declining volumes and the movement to OTC are direct results of the high cost of business at the CBOE.

“I wish people would pay more attention to this, I would love it if people woke up to the fact that the CBOE is not a nice place to do business,” said one equity derivative salesman at a major bank. “Nobody actually wants to do their transactions OTC – they love the transparency and ease of use in listed markets. But it’s just cheaper to execute, CBOE rates are exorbitant.”

The exchange said it continually looks at fees and the proposition it offers customers. It has seen slight dips in options market share in each of the past two months, according to OCC data, but the firm still executed 25.06% of total US options in March, highest among 12 reporting firms.


Participants say exchange fees are not the only reason clients are migrating back to OTC. There is a fear among traders that dealers are likely to be picked off by high-frequency trading firms in cash markets when delta-hedging sizable options positions.

Dealers delta-hedge sold options positions by buying shares in the relevant underlying immediately after the options sale.

“There is increasingly concern that trading on exchanges – particularly in large single-stock positions – exposes market-makers to high-frequency traders who see listed options print and then trade in front of their delta-hedging,” said Jim Strugger, equity derivatives analyst at MKM Partners.

“Asset managers like the OTC anonymity because it mitigates that risk.”

A version of this story will appear in the April 11 edition of IFR Magazine.

(Reporting by Mike Kentz, Editing by Owen Wild)