Burton-Taylor recently published a new study, European Demand for U.S. Exchange-Listed Equity Options 2018. The report, commissioned by the Options Industry Council, is based on interviews with 36 U.S. and European market participants from 31 different firms providing services for U.S. listed equity options trading. The interviews, including 13 firms located in the U.S. and 18 firms located in the U.K. or continental Europe, were conducted during the first quarter of 2018 and focused on the changing perceptions of market participants since 2014.
European investors continue to be active in U.S. listed options markets, with Burton-Taylor estimating that 9% of U.S. order flow originates in the region, based on our new research study European Demand for U.S. Exchange-Listed Equity Options 2018. Although persistently low levels of volatility have reduced activity from hedge funds and proprietary trading firms, institutional accounts such as pension funds and traditional investment managers are increasingly using options as part of strategies. Private wealth managers continue to be active users of options, while there is rising demand from retail investors, especially in more actively traded index, ETF and large cap stock options.
The Appeal of U.S. Options
Our research identified a number of factors that attract European investors to U.S. option markets, with product diversity, pre- and post-trade price transparency, and liquidity all lauded as important benefits. The range of available products offer considerable flexibility for income and risk management strategies, with investors seeing significant potential for options with short term expirations and the use of ETFs. Short term expirations appeal to investors seeking to manage exposure over targeted time frames, especially around earnings and other corporate events. European investors also expect their ETF and index option activity to expand, as the products allow for targeted exposure to industry segments, especially for European investors with large holdings in U.S. index or industry specific segments.
Rising European Exposure to U.S. Equities
Another factor supporting demand is the high level of exposure European investors have to U.S. equity markets. The U.S. Treasury Department recently released data indicating that European holdings of U.S. equity securities totaled $3.3 trillion as of June 2017, up 16% from the year-ago period. No surprise given the magnitude of the U.S. stock market rally, with the S&P 500 index appreciating 136% from January 2010 to the end of 2017. The increase far surpassed the performance of both the FTSE 100 index and MSCI European indexes, which recorded increases of 39.8% and 22.0% over the same period, respectively.
The research also found that demand for U.S. options is correlated to countries with significant holdings of U.S. stock, including the U.K., Luxembourg, and Switzerland. All of these countries have a significant concentration of investment firms and large population of high net worth individuals. Interestingly, Ireland emerged as a country with a large increase in their holdings of U.S. equities, surpassing both the Netherlands and Germany in total ownership of U.S. equities. The influx of global investment firms into Ireland in recent years is supporting this trend, with further increases likely given the uncertainty around Brexit and where firms will ultimately operate when Britain leaves the EU.
Elevated Volatility Expected to Drive Demand
Although industry trading volumes have remained relatively flat in recent years—a result of anemic volatility and shifting investment strategies—resurgent trading volumes in the first quarter bode well for future growth. And investors in Europe are expected to become more active in 2017, as the lack of volatility has been a key factor limiting their activity in recent years. European investment institutions are big proponents of volatility strategies, with volatility an important component of trading strategies and often representing a primary trigger to executing trades. As volatility returns, European trading activity from large institutions, as well as hedge funds and proprietary trading firms will result in rising demand. The impact of rising volatility is already evident in U.S. option markets, with volumes surging 33.1% to record levels in the Q12018, a result of the volatile market environment.
Poised for Future Growth
The European investment industry remains an important source of demand for U.S. options markets, as ease of access, deep liquidity and product diversity provide investors with powerful tools to manage exposure, earn income and effect volatility-related strategies. The region’s significant exposure to U.S. equities provides the foundation for even greater demand, as U.S. options are uniquely suited to supporting investment strategies on these portfolios. Continued market uncertainty from global economic and political uncertainty will ultimately result in rising market volatility, which will attract renewed attention from European accounts with more aggressive trading strategies that require volatility to trade.
Andy Nybo is a Director at Burton-Taylor International Consulting where he is responsible for its Exchange vertical, focusing on how competitive pressures are forcing shifts in business models and strategic initiatives of exchanges. To learn more about how European investors are using U.S. exchange-listed equity options in their strategies see Burton-Taylor’s new report European Demand for U.S. Exchange-listed Equity Options which is available for download at the Options Industry Council website here.