US Equity Index Derivatives: The Next Phase of Institutional Discovery

Asset managers are focusing more attention on index derivatives as market structure changes in both OTC and cash markets impact portfolio decisions. As institutions change how they manage cash flows and risk exposures, index derivatives will see greater growth as part of the evolution of existing strategies.

Index derivatives represent advantageous proxies for traders needing to shift trading risks, especially in fast moving markets or when they need to rebalance portfolios within limited time frames. In addition, they are used to lower trading costs due to their inherent leverage and can provide an efficient mechanism to access foreign markets, as the costs of participating directly in local markets can be prohibitive.

Today, US derivatives trading is becoming more electronic, more competitive, and faster. As market volatility increases, buy-side firms will incorporate different types of products to more quickly manage risks and provide managers with the ability to get in and out of markets swiftly. Based on our sample, current usage within strategies and portfolios appears to be a positive indicator for longer term usage while the aptitude for change varies between a willingness to look at new and interesting products and realistic expectations that market activities will be significantly influenced by the level of market volatility.

Asset managers will continue to use index products to equitize cash, hedge risk, gain exposure to underlying reference markets, and look for new ways to generate alpha when provided with the right opportunities. If the latest record volumes are any signal of what to expect in 2015, the changes for increased adoption are already taking hold.