US Options Trading 2014/2015: The Buy-side’s Insatiable Thirst for Liquidity

Despite reducing their level of options trading in 2014, the buy side remains bullish on using options, especially as volatility returns and rising assets under management provide a solid foundation for expanded trading. That’s a refreshing change because 2014 was marked by a lack of conviction, with traders having to work hard to find a reason—and an opportunity—to trade.

Low volatility had the expected impact on buy-side options traders in 2014, with their volumes declining as traders identified fewer opportunities to trade. Investors were writing fewer options as premium income dried up and they had to be more aggressive in identifying potential opportunities to trade. Crises du jour did provide windows of opportunity in 2014 but these occurrences were few and far between. The frequency of these volatility events, however, accelerated in the second half of the year, with market gyrations becoming more common, and that bodes well for 2015.

Executing a trade has become an increasingly challenging proposition, especially for large trades in less active names. Liquidity has dried up, both on dealer capital desks and on screens. Hedge funds can’t get access to capital as dealers cull client lists and restrict the parties with whom they are willing to trade. Electronic markets are thin and traders complain about fading liquidity whenever they need to get a trade done.

Hedge funds are becoming an endangered species in listed options markets, as limited trading opportunities in the low volatility environment and the continued focus on improving broker balance sheets are forcing many hedge funds to pull back from trading options. Add to that the closure of hedge funds that fail to meet investor expectations of returns and the decline becomes even more notable. The lack of volatility has been a growing deterrent, but the continued culling of broker client lists has become a growing concern for many of the hedge funds we interviewed. In contrast, asset managers continue to be enamored with options strategies and are slowly but surely expanding their use of options within strategies.

The past 12 months have hardly been an options trader’s nirvana but there is light at the end of the tunnel. The lack of volatility and incessant upward grind in equity prices provided few opportunities to trade but a resurgence in fourth quarter volatility brought a measure optimism for the industry. And if the first few days of 2015 are any indication, options traders will be presented with a wealth of opportunities that have been sorely lacking in recent years. Traders tend to be an optimistic bunch and with any luck, this optimism will translate into renewed interest, higher trading volumes and a boon to the options industry in 2015.