Options on Futures: Use Cases in Efficient Risk Management
The recent market volatility is playing havoc with the investment strategies of portfolio managers around the world who are still trying to make sense of shifts in international economies, changes in market sentiment, and spiking volatility across nearly all asset classes. The challenges of managing risk exposure never abate, but recent market conditions are testing the wherewithal of all but the most placid investment strategists.
One area of continued investor interest has been in the options on futures (OOF) markets, where volumes have continued to grow amid the increased market volatility, and rising investor interest in using more complex strategies. These strategies run the gamut from simple hedging to premium harvesting and increasingly, multi-legged trades across expirations designed to mitigate risk between production cycles and time horizons.
The rising adoption of OOF’s has been facilitated by a number of structural shifts, including the increasingly electronic trading environment and a corresponding rise in liquidity as more and more firms include OOF’s in their strategies. Total volumes have seen a compound annual growth rate (CAGR) of 12.8% since 2009, with trading volume averaging 3.0 million contracts a day in the first nine months of 2015, as compared to an average 1.5 million contracts a day in 2009. The transition to an electronic trading environment has been critical, with the impact seen across all asset classes. Electronic trading accounted for more than half (55.8%) of total trading in the first three quarters of 2015, up from just 18.0% in 2009
It is not solely electronic execution that has driven increased product usage. As OOF markets have become electronic, firms also gain access to more comprehensive data sets, which feed analytics and allow for greater complexity in strategies. The ability to design a complex strategy involving multiple legs across multiple expirations and potentially multiple asset types and submit that trade to the market opens up an entire new trading constituency.
The liquidity of the OOF marketplace is leading to a rise in automated trading strategies that are designed to take advantage of rapid market movements. This has spawned an increase in technology and vendor support for these clients. New trading tools, enhanced data sets and more powerful analytics are being offered to service this rapidly expanding segment of the market. As electronic tools are rolled out and adopted by a broader range of clients it will lead to further volume increases in the OOF market.