Market Trends in Futures and Options

Recent Market Volatility has Impacted the Use of Derivatives

Apr 26, 2009

Volatility in the markets has affected both structured derivatives along with futures and options. What lessons can the individual investor learn from the major players?

Research from the consulting firm Greenwich Associates indicates that while the use of over-the-counter, dealer traded, structured derivatives has seen a marked decline in recent months, the use of exchange traded standard futures and option contracts has seen the opposite, a rise in their use by institutional investors for a variety of reasons. Perhaps some of the strategies employed by these institutions can help the average retail investor.

Product Usage Overall

According to that same research, many institutions in North America use futures and options as a means to take a position, whether long or short, in the underlying issue or index. Given that, roughly two-thirds use equity derivatives as a functional adjunct to their fundamental investment strategy or philosophy.

Slightly less than two-thirds of institutions use futures and options to execute their opinion on the general direction of the market, sector or individual issues and just under half use exchange traded derivatives to establish more complex strategies.

Product Sector Usage

Just over half of North American institutions use index futures with hedge funds participating in this sector at just under half. The opposite is true in usage of Exchange Traded Funds (ETF) with just over a half of institutions using ETF’s and not quite two-thirds hedge funds.

To a lesser extent, institutions use futures and option contracts for index or sector swaps and swaps on a particular portfolio or basket of stocks while usage for access to the underlying sector or issue is a distant last.

Popular Strategies

There are some slight differences between institutional investors overall and hedge funds, but on balance the most popular strategy is single-stock listed options with roughly three-quarters using them. The next most popular with 60% to 70% participation is listed index options and the third most popular strategy with roughly half of institutions using them is options on sector Exchange Traded Funds.

Much less popular were the more exotic type of uses such as futures and options on volatility, dispersion and correlation type trades and variance swaps on indexes and single stocks.

Considerations

There are a number of considerations any investor should make about their broker. Being penny wise and pound foolish about commissions is a major point. Institutional investors use a "high-touch" sales professional over half the time for futures and three-quarters of he time for options. Electronic execution accounts for the reciprocal, whether to the broker’s desk or directly to an exchange.

Consider what institutional investors consider important factors in their choice of brokers: Certainly pricing is important but so is the expertise of the sales professional, their understanding of the client’s investment strategy, their market judgment and sense of timing and willingness to commit capital to facilitate trades.

Remember to consult your own investment professional to determine if employing futures and options is an appropriate and suitable vehicle for you to use.

The copyright of the article Market Trends in Futures and Options in Derivatives Investing is owned by Dean Lundell. Permission to republish Market Trends in Futures and Options in print or online must be granted by the author in writing.