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Wednesday, September 03, 2014

How is the Option Market Lately?

We all know volatility is extremely low in option market, in accompany with the extremely low realized volatility in equities.  How is the option overall doing? Does the low volatility cause the low trading volume and eventually leads to the death of the option market, according to some apocalyptic speculation?

If you look at the recently daily published OCC volume number, it does show the pattern of the volume petering out, 13 – 15 million contracts traded in equity single+ETF (non-index) category.  In Figure 1, we show the monthly trading volume since 2003.  It does show the volume flatten around 300 million per month since 2008.

A much more accurate measure of option trading activity, especially when related to volatility, is a measurement first proposed by us, the Volume-Vega or OpenInterest-Vega (OIVega).  It is basically the Vega calculated at the implied vol for the volume or Open Interest.  Figure 2 shows the corresponding Volume-Vega trend.

Figure 1.  Monthly Equity Option Volume from Jan 2003 to August 2014 (the spike in August 2011 was due to our Michael Corigliano joining BellCurve… or maybe due to the Congress debt ceiling crisis.)

Figure 2.  Monthly Equity Option Volume-Vega.

If you squint your eyes, you may see somewhat an uptrend since 2009, even though these two years the Volume-Vega is basically the same as Volume, flatten out.

But here is a very upbeat chart that would wash away the anemic feeling if you just look at the volume:  the number of equity options has been increasing steadily or even rapidly in recent years.  Figure 3 shows the number of strikes in the entire US equity market (currently at 350K, the number of options is double that number, 700K).  This is quite a change from the boom years of options in early 2000 when there were typically 100K options in the market available to trade.

Such rapid increase is due to the two factors: 1. The introduction of weekly options;  2. The normalization of option symbolism in 2010 (which removed the archaic monthly cycle symbol and the special symbolism for LEAPS options – anyone still remember the chaotic process of LEAPS Conversion that the IT department used to have to go through each year?)  Such normalization (through the standard OSI symbols) allows options to be efficiently defined and managed, while options traders can focus entirely on the volatility or strategic aspects of options.

The increase of total option strike count in US market comes from two aspects:  the steady (but slower) increase of number of underlying symbols that have options (now stands just above 4000), as shown in Figure 4; and the much rapidly increase of  number of strikes per names (Figure 5).

So how can we reconcile the fact that total option volume is anemic, while option products are growing rapidly and healthily?  My explanation (which will be the subject of more detail research in future) is, these days, with the advance of multiple electronic exchanges and electronic trading tools and algo, there are relatively fewer big concentrated trades in the option space, but more spread-out small trades.  These trades are more concentrated around the at-the-money areas (thus bigger unit Vega) rather than in more speculative way out-of-money options  (which has smaller unit Vega), thus explaining that the Volume-Vega is actually showing a slight uptrend that does not exhibit in Volume history.

Figure 3.  Number of strikes in US equity option market.

Figure 4.  Number of US equity symbols with active options.  Currently over 4000.

Figure 5.  Number of strikes per symbol.  Currently there are about 90 strikes per symbol in average, or 180 options per equity name.

The implications of these trends are several.  First, the option market is far from dead, but flourishing through the recent normalization of symbolism and electronic trading (which I described in a previous article).  

Secondly, as active participants of option market, this is a great opportunities that didn’t present in the previous generation of option traders: we have now much wider and complete volatility surfaces to trade on, and we have much more relativity opportunities in that space. Trade relative vol, rather than absolute vol level, is the name of the game.

Thirdly, the technology and information providers like Bloomberg need to realize this new reality and face up and catch up, rather than live in the archaic world of 10 years ago when option traders typically deal with 100,000 options in the entire universe, rather than more than half million options like today.

Derek Wang, CEO, Bell Curve Capital LP. dwang at 

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