Equity indices have been around for decades, but they have never been so popular. And to judge by the futures and options markets linked to them, the latest wave of growth in index trading has only just begun.
In 2010, some 7.49bn equity index derivative contracts were traded at the world’s exchanges – 1bn more than ever before, and accounting for one third of all listed derivative trades.
The 16% growth in this market, over 2009’s levels, helped push the overall futures and options market to a record high volume.
But aggregate trading statistics do not tell the whole story. The strongest sign that this growth has a lot further to run is the rapid expansion of trading in some particular contracts, especially in emerging markets, and the rash of new products being launched.
There was a clear pattern in the new contract listings of 2010. Rather than the big exchanges cutting and dicing their existing indices into smaller pieces, or more complex formats – something that has already been done – the fashion is to create contracts based on foreign indices.
It’s worth bearing in mind that until recently, there were relatively few exchanges where one could trade the stock index of a foreign country with any liquidity.
But with the financial crisis in the West making the rise of emerging markets even more obvious, investors are hungrier than ever for exposure to fast-growing stockmarkets. And nowadays, many of them like to take that exposure – or hedge it – in index form.
At the same time, the swelling pools of capital in Asia want to trade European and US stockmarkets in their own cities. Exchanges and index providers are eager to satisfy them.
Crisis leads to stagnation
The last few years have not all been rosy. As equity markets experienced lower overall turnover during the financial crisis, so did futures and options based on indices.
Global volume was flat in 2009, at 6.43bn contracts, against 2008’s 6.49bn. But without Asia’s 9.6% growth, to 4.21bn contracts, the world market would have shrunk. Volume fell 17% in Western Europe and 14% in North America.
Asia already accounts for 69% of global volume by number of contracts, though not necessarily by notional value.
Last year was much better, with 0.66% growth in Western Europe and 5% in North America, while Asia put on 23%.
Even so, at CME Group, where more than 550m contracts trade every year of its E-Mini S&P 500 Futures, volume was flat in 2010, with the smaller E-Mini Nasdaq 100 contract taking up the slack from a slight decline in the S&P.
Scot Warren, head of CME’s equity index services business, says levels of equity volatility over the last year, some 75% lower than in 2009, contributed to weaker turnover. “Index derivatives products are a hedge, so are very highly correlated with volatility,” he says.
Not all exchanges have been affected in the same way.
The Chicago Board Options Exchange, which lists the successful S&P 500 Option, hosted the trading of some 270m index options in 2010, up from 222m in 2009. CBOE has a market share of 93.8% in US index options.
More than half of the exchange’s expansion in 2010 can be attributed to the 87% increase in volume of the CBOE Volatility Index (Vix) Option, a complex product that market participants are still learning how to use. Trading of Vix Futures at the CBOE Futures Exchange grew nearly fourfold to 4.4m contracts.
Korea on a roll
It was an extraordinary year in South Korea’s equity markets. The Kospi 200 Index itself rose 22%, a bull run unperturbed even by an ugly worsening of tensions with North Korea.
Volume in the Kospi 200 Option, the world’s most traded listed derivative, by number of contracts, had been stable to mildly rising, in the range of 2.5bn to 3bn contracts a year, since its remarkable leap to prominence in 2004. In 2010, trading leapt from 3bn to 3.6bn contracts.
The picture was very different at Eurex. Total index volume edged upwards in 2010, from 800m contracts to 810m, but that masked a 12% recovery in Euro Stoxx 50 Index Futures trading, partly offset by a 5% decline in Euro Stoxx 50 Options.
Steffen Koehler, a director at Eurex, says that from late 2009, during the financial crisis, many considered it a safer harbour to be invested in interest rate derivatives. However, since the middle of 2010, equity derivatives, including index contracts, have enjoyed a revival of open interest and trading volume.
“This is not at the expense of interest rate derivatives,” Koehler says. “Rather, it seems, both are experiencing an increase in activity. But for index derivatives, this represents a definite return from what has been a volume slump.”
Much of the recovery is due to the return of high frequency traders. “Our typical market participant is involved in both index options and futures, but the rise in futures volumes is particularly a result of a lot of high frequency traders coming back over the last year,” says Koehler.
HFT firms’ preference for futures is clear from the open interest/volume ratios for each of the Euro Stoxx 50 products. Futures and Options Intelligence data for December 2010 shows that month end open interest for the futures was 2,115,000 contracts, or 8% of the volume traded that month. Open interest in the options, after its typical December dip, was 32.8m contracts, or 179% of the volume.
“Clearly, the Euro Stoxx 50 Future has benefited from the return of high frequency traders wanting to settle positions in short order,” says Koehler.
Emerging powerhouses
As is clear from these trading patterns in the world’s leading equity index derivatives, the market is moved by hidden winds of sentiment that are hard to predict, and even difficult to interpret retrospectively.
But in some emerging markets, secular changes are under way that are so powerful they mask these shorter term currents and cycles.
Apart from the Vix Options, already mentioned, the three fastest growing equity index derivatives in 2010 were in three of the Bric countries – Russia, India and China.
The aggregate volume for National Stock Exchange of India’s index options grew 65% to 530m contracts. NSE’s index futures fell 20% at the same time, but the exchange’s total of 686m contracts is now chasing the likes of Eurex and CME, by number of contracts.
Almost as impressive is the RTS Index Future at Russian Trading System in Moscow. Volume rose by 50% in 2010 to 225m contracts, helped by a lively local culture of algorithmic trading as well as growing interest from foreign investors (see Russian DMA Roundtable, page 33).
Perhaps the most exciting event of the year, however, was the long-awaited arrival of China’s first listed financial derivative for 10 years, the CSI 300 Index Futures at China Financial Futures Exchange.
Launched in April, the instrument had by July reached a monthly volume of 7.5m contracts. That made it the ninth most traded equity index contract in the world that month.
And it’s a big contract – worth Rmb300 ($46) times the index, which is now around 3,000. That makes each lot worth $138,000, against Eu30,000 for the Euro Stoxx 50 Future and $65,000 for the E-Mini S&P 500.
The highly speculative nature of the flow was clear from the tiny open interest at the end of July – just 30,851 contracts. That is only a third as much as the next lowest figure among the world’s top 25 index derivatives.
This was not what the Chinese authorities had hoped for when, after years of deliberation, they permitted trading to start. The huge size of the contract and heavy margin requirements were designed to discourage speculative day trading.
So in late June, the exchange rang brokers and told them to cool things down. Clients were limited to trading 1,000 lots a day each. It worked – volume eased off to about 4.5m contracts a month. That’s still about $600bn of trading, though the open interest is only about $4bn. The equivalent figures for the E-Mini S&P in December were $2.28tr and $161bn.
Cross-listings flourish
If the tremendous growth of equity index derivatives in emerging markets shows the surging demand for these instruments, then the natural response of exchanges has been to open more channels for that demand to flow through.
A strong trend among US, European and Asian exchanges in 2010 has been creating new derivatives based on indices already traded at other exchanges.
The idea is to bring the world’s major indices to new audiences, in the time zone and format that suits them, and at the exchanges they already belong to. This creates new opportunities for exchanges, and index providers are also keen to have their benchmarks traded as widely as possible.
In the past year there has been a rash of announcements of such deals. In August, Eurex listed an innovative one day futures product which expires nightly into an open Kospi 200 Option position at KRX. The CME has also added Kospi 200 Futures order routing to its Globex platform.
In October, Eurex went live with dollar-denominated futures and options on the Sensex index of 30 top stocks on the Bombay Stock Exchange.
Eurex and the BSE say each party will benefit through a widened investor base. The European exchange will offer the Indian benchmark to its members, and BSE believes the move will also boost domestic trading, even though foreign firms cannot trade the contracts in India.
A particularly interesting development is that the Singapore Exchange launched in December futures and options on the Euro Stoxx 50 Index – Eurex’s crown jewel. This is unusual because an Asian exchange is offering a European risk.
But far from seeing SGX’s contracts as competition, Eurex is helping to market them. It believes that by developing trading of SGX’s dollar instruments, it will boost trading of its own euro-denominated products. One spur to this, Eurex executives say, is Singapore’s rich history of spread trading. Firms will arbitrage the two contracts, they believe.
SGX, of course, is already a leader in offering foreign equity indices. Its most active contracts are futures on Japan’s Nikkei 225, the MSCI Taiwan Index, India’s CNX S&P Nifty, and the MSCI Singapore Index. It also has a FTSE Xinhua A50 Index Future, which tracks the performance of Chinese stocks.
Building on the success of its Nifty Index Futures, SGX expects to launch Nifty Options in 2011.
Providers struggle for supremacy
The leading global index providers, like FTSE, S&P, Dow Jones and Stoxx, are jostling to have their indices more broadly traded in the form of futures and options.
Being the first to a new market can make all the difference, argues Robert Shakotko, managing director of Standard & Poor’s Index Services. “When Dow Jones first licensed their indexes for derivatives trading just over 10 years ago, a lot of people said that they would out-trade S&P, and that never happened. We not only retained, but also increased our market share,” says Shakotko.
At CME, the E-Mini S&P 500 Future now trades more than 2m contracts a day. A few blocks away at the Chicago Board Options Exchange, S&P 500 Options trade about 700,000 to 800,000 contracts a day.
S&P indices are thus the basis for about 80% of the US index futures and options market. “We have had relationships with these exchanges dating back to the 1980s,” says Shakotko.
Aware of the benefits it has enjoyed by being first to market in the US, S&P is hoping to replicate this strategy, especially in markets like India that are poised to take their place as pillars of the world economy in the 21st century.
The deal between S&P, the CME, which has exclusive rights to list S&P 500 futures, and the NSE, looks like being the first of many similar agreements worldwide.
“There are other possibilities we are working on to take the S&P 500 in a derivative format to other parts of the world,” says Shakotko. “In particular, we want to address the needs of people who are locked into jurisdictions where there are impediments to moving capital between it and the rest of the world.”
China is high on S&P’s list, Shakotko revealed, though he would not say whether S&P was already in talks with Chinese exchanges or regulators about listing any index derivatives there.
Covering the world
Another major index provider, Stoxx, is also trying to take its indices global, through such initiatives as the US dollar version of the Euro Stoxx 50 Futures and Options, which were listed for trading at SGX in December.
“The product draws on the liquidity threshold that is the primary listing on Eurex,” says Konrad Sippel, executive director of sell side business at Stoxx, which is owned by Deutsche Börse and SIX Swiss Stock Exchange. “There are obvious advantages in making it available during Singapore trading hours and denominated in a different currency.”
Trading of the contracts has not “blown the roof off yet”, says Sippel. That said, the exchange is “trying to get initial trading going”.
As of January 2011, open interest was 151 contracts, equating to roughly $42m. “These figures are nothing like the European figures, but there have been trades building up and it will be interesting to see how it develops over the next few months as momentum gets going,” Sippel says.
If the contract reaches a certain degree of liquidity, high frequency traders may get interested. Carolyn Lim Siew Choo, a spokesperson for SGX, says HFTs account for about 30% of the exchange’s total derivatives volume.
“The launch of the SGX Euro Stoxx 50 Futures and Options will allow investors to respond earlier to developments occurring outside European trading hours but affecting European equity markets,” she says.
For Eurex and Stoxx, the SGX listing is only a starting point for bigger plans, says Sippel. “Making the Euro Stoxx future available in Singapore is very much a first step in making Stoxx a global provider, both in terms of client base and product range,” he says.
While Sippel would not be drawn on where Stoxx would next stake a claim on the world map of indices, he confirmed that the firm was in talks with derivatives exchanges about future listings.
As he put it: “We would like to see the indices traded for as long as possible every day, and make them available to new groups of traders in their own denomination.”
BOX
Exchanges make Nifty moves
The National Stock Exchange of India’s Nifty 50 is one of the hottest index properties at the moment. CME Group was probably more encouraged than put off by the Nifty’s popularity in Singapore when it struck a deal with NSE to list Nifty futures. Trading of E-Mini and E-Micro versions of the futures began in July.
“Allowing US market participants to gain exposure to a hugely growing overseas equity market like India through index derivatives is an ongoing interest of the exchange,” says Scot Warren, head of equity index services at CME Group in Chicago.
However, the Merc’s Nifty futures have yet to gain much traction. In December, 131 E-Mini and 8,161 E-Micro contracts were traded. Volume at SGX, whose futures are equal in size to the CME Micro ones, was 866,000 contracts.
Even these volumes are dwarfed by those at NSE itself, where 11.4m index futures, mainly Nifty instruments, were traded in December, and 50.7m options.
Like SGX, the NSE wants to offer its members and their clients exposure to foreign markets – including Western ones. It has struck a deal with CME to list a version of the S&P 500 Futures in rupees. They are expected to start trading later this year.
Catering to this new market, the Securities and Exchange Board of India released rules in January, setting out its policy on Indian exchanges offering derivatives on foreign share indices.
“We are going to start an intensive investor awareness initiative to help investors to understand these products in India,” says Divya Malik Lahiri, head of corporate affairs at the NSE. “The product listings will help many Indian investors to take a view of the US economy and help in overcoming the problem of limits on how much an Indian investor can invest on a foreign platform.”
Warren explains that the CME was happy for an Indian version of its S&P contract to be listed because the country’s capital controls make it difficult for local residents to participate in offshore markets. The CME is looking for other countries that fit this bill. “We are working with S&P, Dow Jones and Nasdaq for opportunities to expand their reach,” he says.
Judging by the huge popularity of Nifty futures and options in India, the NSE’s S&P contract might be expected to gain much bigger volumes than CME’s Nifty instrument.
And that is just the beginning. The NSE is also talking to the London Stock Exchange group, and its index partner, FTSE.
The Indian and UK exchanges signed a letter of intent in July, under which NSE could gain a licence to list FTSE’s indices in India. “In return, we are expected to give the licence to trade Nifty options to the London Stock Exchange,” Lahiri says.