BM&F Bovespa and CETIP are readying a series of initiatives that should incentivise diversity in an equity options market dominated by just two names. Elise Coroneos reports.

Brazil’s equity options market may be one of the largest in the world but it’s also — perversely — a comparatively shallow one. That’s because Brazil is home to the two most traded equity options in the world — those representing Vale, formerly known as Companhia Vale do Rio Doce, the large multinational mining corporation, and Petrobras, the largest company in Latin America by market capitalisation and revenue.

The leap in growth seen on Brazil’s equity options market — the number of trades increased from 11.8m in 2008 to 14.9m in 2009 — was, however, largely driven by the increase in trading in these two names, according to data from the International Options Market Association, which represents a global group of exchanges and clearinghouses affiliated with the World Federation of Exchanges.

In 2009, trading in Vale’s equity options almost doubled to a quite extraordinary 48% of the market. Petrobras in second place in 2009 took 42% of trades.

So, given the pair’s 90% domination of the sector, what liquidity is there for investors keen to take a position in other companies? And what kind of future does the sector have?

For the moment, liquidity is indeed scant in other stocks. However, the stage is set for change with BM&F Bovespa, Brazil’s largest stock and derivatives market, and CETIP, its over-the counter clearing house, getting ready to implement strategies to expand liquidity in 2010.

Enter the market-makers

BM&F Bovespa’s plans to increase equity option market liquidity will involve the implementation of a newly formed market-maker programme to be executed this year, according to Julio Carlos Ziegelmann, the equity products officer at the exchange.

As part of the programme, the exchange will put market-makers in place on the 10 most traded equity options behind Vale and Petrobras.

While the number of market-makers to be used has yet to be determined — there might be the same market-maker for more than one stock, or there might be more than one market-maker for the same stock option — the goal is to give the Brazilian equity option market liquidity and depth in more than a couple of names.

While the equity options to be included in the programme has still to be officially released, based on 2009 figures, the top 10 traded equity options in Brazil behind Vale and Petrobras were Ibovespa, NET Serviços, OGX Petróleo e Gás Participações, Gerdau, Itaúsa, Itaú Unibanco, BM&F Bovespa, ALL — América Latina Logística, GVT (Holding) and Usiminas.

Also to be considered when settling on the final form of the programme will be the fact that of most value to the market will be equity options in companies without a lot of liquidity in the cash market. This is because the cash market in Brazil is more developed than the derivatives market.

This attempt to rectify the issue of liquidity, however, will come at a cost for the exchange. “Market participants who are interested will be able to receive reduced trading fees,” says Ziegelmann. To receive this reduction in fees, however, market-makers will need to provide a minimum amount of auctions.

“Market-makers will have to virtually buy and sell offers all the time in the market, so there will be spreads in the market, and these spreads will have to be very tight,” says Ziegelmann.



Transparency made clear

While BM&F Bovespa is responsible for exchange-traded and some OTC contracts, the majority of OTC equity options are handled through custody and settlement house, CETIP. Brazil’s high level of transparency — all trades, even OTC transactions, must be registered with an authority — is often a surprise to foreign investors.

This transparency, a product of Brazil’s period of hyperinflation and attempts to keep a tight oversight on its banks’ exposures, is a helpful defence in avoiding situations such as that seen in the US over the past 18 months, where complex derivatives transactions containing hidden toxic assets have ended up holding an entire economy to ransom.

Instead of seeing regulation requiring transparency as a burden, Brazilian authorities say they believe this level of oversight is prudent, but also gives investors security, thus encouraging greater market participation.

As such, CETIP is setting plans in place to deepen the liquidity of the OTC equity options market. According to Wagner Anacleto, CETIP’s chief operating officer, the company is working on broadening its infrastructure so as to allow it to provide different types of equity derivatives, including options. “What we see in the Brazilian market are entities such as banks and brokerage houses looking for more flexible options,” he says.

To enable greater flexibility, such as allowing investors the ability to set up any kind of strike price, CETIP is bolstering its information technology platform to provide the ability to engage in OTC transactions using automation, says Anacleto. “Delivering new kinds of derivatives, especially in the area of equity and index-options are our focus this year,” he says.

CETIP has developed a reputation as being a centre for innovation in Brazil’s derivatives market. Five years ago the market was dominated by futures, swaps and a small number of options, mostly calls/puts and caps/floors, whereas today exotic options and bespoke derivatives trade regularly.

Furthermore, in 2010, CETIP is looking at what kinds of additional services, or regulation, it can perform in the OTC environment to bring about greater market participation. According to Anacleto, the company is looking at whether it can calculate options exposures and aggregate options in the OTC market. “This is new in Brazil and in the world as a whole. Nowhere do you have the ability to register transactions to control collateral,” he says.

Market factors

Overall, the derivatives market in Brazil is increasingly of interest to foreign investors, according to Carlos Eduardo Schahin of Schahin Securities, a pioneer in the derivatives markets. Foreign investors accounted for 5% of participants in Brazil’s options markets in 2000, a figure which had increased to 8% in 2009.

Schahin Securities was the first securities firm to provide direct market access for international clients wanting to trade Brazilian assets.

Numerous macroeconomic factors such as elections and issues with Brazil’s current accounts are likely to provide the volatility needed for a dynamic equity options trading environment this year, says Schahin.

Another factor likely to contribute to a healthy equity options market is the number of Brazilian companies readying public offerings over the next 12 to 18 months, says Daniela Anversa Sampaio Doria, a São Paulo-based partner at Pinheiro Neto Advogados, one of the largest law firms in Latin America.