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Assessing the global derivatives landscape
When it comes to EU market structure in this space what changes should be front of mind for traders? When considering the EU market structure, several key changes are essential for traders to be aware of. Firstly, market dynamics- in contrast to the US, where the CME pit is a primary source for bids and offers with a central clearing tape, the European market is more fragmented around legislations, countries and exchanges. However, the upcoming consolidated tape announced by the European commission in January 2021 for bonds is a step in the right direction.
Second is cost efficiency- 0DTE options( popular in the US) offer a cost-effective hedging solution with narrower bid-offer spreads( 0.25 cents) compared to futures( five cents), while these options are still to take off in Europe. Coupled with this is market efficiency, Europe has an efficient market, particularly with EUREX excelling in listed products, which supports reliable execution.
Another point to highlight is liquidity sources, wherein diversified liquidity sources are vital for traders to achieve better execution in any market conditions.
Finally, important to note is relationship building. Cultivating strong relationships with market makers is critical, as trust can enhance a trader’ s ability to execute large transactions while managing risk without market impact.
Tell us more about the shifting liquidity dynamics between OTC and listed derivatives. The liquidity dynamics between OTC and listed derivatives are evolving due to several factors. A changing regulatory environment is promoting portfolio transparency, leading to increased adoption of listed derivatives among certain client types, such as hedge funds and asset managers. These clients favour listed options for alpha generation, speed of execution, and better price transparency.
Conversely, OTC options remain appealing to insurers for accounting reasons, initial and variation margin optimisation and offering customisation options such as specific strikes and broken dates. Notably, we can see buysiders asking both OTC and listed versions, with the best price determining the choice, regardless of the format. However, note that the open interest of listed products should not be the only indicator of liquidity.
Dmitri Mongeot, derivatives trader at AXA Investment Managers, sits down with The TRADE to unpack the key EU market structure changes to keep an eye on, the shifting liquidity dynamics between OTC and listed derivatives, and the persistent impact of EU and US divergence.
Also, the listed market is introducing more alternatives, such as flex options, particularly relevant for EU single stock options. Regulatory changes, like UMR, may further drive migration from OTC to listed derivatives. Ultimately, we believe there is no significant liquidity difference between vanilla listed and OTC equity options.
How are the EU and US different when it comes to their derivatives and retail processes? What is the impact of this going forward? The EU and US exhibit notable differences in their derivatives and retail processes, significantly influencing market dynamics. First, liquidity is considerably deeper in the US than in Europe, with retail participation in the US accounting for about 50 % of market size, compared to much lower levels in Europe. This heightened retail engagement drives the stronger adoption of 0DTE options in the US.
Market makers in the US benefit from an aggregated pool of information, which enhances their ability to analyse and respond to market conditions. It’ s worth noting that the US features a decentralised exchange structure with co-location competition, whereas Europe comprises multiple exchanges, countries and regulations that may lead to fragmentation.
Execution styles also differ: European trades are often executed against a reference price, with adjustments based on underlying delta levels, making price comparison easier, while the US trades‘ at risk’. Also, US retail participation in listed equity options is significantly higher, with daily options trading in SPX representing about 50 % of overall trading volume, while 5 % for the SX5E.
Lastly, the US is already operating under a T + 1 settlement framework while Europe is working on it.
From your perspective, what is the best way to encourage greater participation in these markets? To foster greater participation in derivatives markets, particularly in Europe, several strategies could be implemented. First, it is crucial to increase retail participation, as evidenced by the US, where retail clients account for a substantial portion of the 0DTE market( 50 %) and 70 % of SPX trading in the MSCI World Index.
For institutional participants, it’ s important to highlight the depth and breadth of listed markets, encouraging them to focus on the advantages rather than getting bogged down by the complex documentations associated with OTC trading.
Education plays a vital role in boosting retail engagement. By providing resources and training, potential retail investors can better understand derivatives and their benefits, making informed decisions about participation.
Additionally, in Europe, a shift of focus from traditional savings accounts, such as towards equities and derivatives markets could help attract a broader institutional and retail audience and shift from a conjunctural increased European participation to a more structural participation.
22 THETRADETECH DAILY