Options Market Ripe for New Entrants as Demand Builds
Lime considers direct access and order routing as high-frequency traders embrace options
March 16, 2009
As the equities market flounders, options are drawing increased interest from high-frequency traders and traditional asset managers, prompting broker-dealers and other market participants to test the water.
New York-based Lime Brokerage, which executes large volumes for active equities traders, is exploring options-market opportunities such as market data, low-latency direct access to exchanges and a smart-order router. If Lime decides to proceed, it could have services up and running relatively shortly, said director of options Jonathan Schlossberg.
BATS Exchange is also considering offering options, although it is looking at other asset classes as well. Direct Edge, an electronic communications network (ECN) that expects to receive two exchange licenses by year-end, may also launch an options platform.
Options volumes have grown by 30 percent annually over the past five years. In 2008, amid extreme volatility, brokers earned $2.6 billion in options-related commissions, according to Tabb Group senior analyst Andy Nybo. That number is a "large part of potential business activity," he said, and is likely to continue growing.
"Asset managers have only scratched the surface in terms of using options in portfolio strategies," said Nybo, adding that they are "enamored" by using options to hedge risk and generate revenue through strategies such as covered calls.
The demand may extend to corporations as well. Chris Zingo, SVP of the Americas at SuperDerivatives, a provider of options valuation and risk systems, said the de-leveraging of bulge-bracket firms has opened a window for regional brokers, especially those attached to regional commercial banks, which extend credit to thousands of corporate customers. Zingo said he has mainly noticed an uptick in interest in over-the-counter derivatives--his company's specialty--but exchanged-traded options are likely a beneficiary.
Although Lime's options offerings would appeal to traders who place an emphasis on speed, it is also targeting institutional investors. Schlossberg estimated that "customers"--an exchange designation for participants who execute market orders and take liquidity--make up about a third of options volume, of which about 55 percent are institutions-traditional asset managers and large hedge funds. The remaining 45 percent is mostly retail investors, with high-frequency and professional traders executing single-digit volume percentages.
The latter two investor types make up a large portion of Lime's customers on the equity side, which would give the firm a captive user base. Schlossberg said that if Lime decides to develop smart-routing technology, it will offer an institutional version that stresses price and another that highlights speed.
Active Investor Influx
Jeromee Johnson, president of 3D Markets, an options dark pool that began operations last year, said that it may be an optimal time for services aimed at active traders. While open interest in options was down about 40 percent at the end of January from the year before, volume was off 15 percent, noted Johnson. He attributed the discrepancy to the inflow of active investors who typically close their accounts at day's end rather than hold positions overnight.
An independent smart-routing system could find customers for other reasons: Most options routers are offered by firms such as Citadel Derivatives Group, Citigroup and Goldman Sachs, which also make markets. OptionsXpress launched a router in 2007 and bolstered it last summer. "We built it after experiencing the limitations of several of the market makers' routers," said Peter Bottini, EVP of trading and customer service at the Chicago-based online brokerage, which caters mainly to retail investors.
