Curatia Analysis for Mon, Feb 12, 2024

Unpacking the Newfangled Trading Trends That Pushed Options Markets to Record 2023 Volumes — and Why 2024 Figures to Be Even Bigger  Sponsored

Jason Dibble Co-Founder, Editor in Chief

From buy-side firms’ embrace of zero-day-to-expiry options to their growing deployment in systematic trading strategies, institutions’ turn to novel options-trading approaches drove record volumes in 2023.

The trend is poised to continue in 2024 amid the addition of new trading venues and more granular expiries as well as a retail revival. Index options in particular could see rapid growth as macro developments including shifting interest-rate policies and looming U.S. elections encourage individuals and institutions to gain exposure and manage risk at a broader level.

Balanced Boom

It’s no secret that options trading is in the throes of a boom for the ages. Volume soared to unprecedented heights in 2023, averaging around 44M contracts traded daily — more than double the pace of four years ago and a thirteenfold increase since 2000.

But that activity has also been more balanced than pundits have suggested, highlighting a market poised for continued growth on numerous fronts. While short-dated options have been instrumental in the boom — the share of trading in contracts expiring in five days or less hit a record 49% in October — other market segments have likewise seen brisk growth.

Assets in options-tracking funds surged 50% to a record $64B. Average daily volumes in the index options market meanwhile rose 31% YoY, with Nasdaq-100 Index Options (NDX) ADV climbing 59% on the strength of a banner year for the index.

Behind that multi-front growth lies an equally nuanced picture of investor participation. Experts initially ascribed explosive growth in 0DTE options trading to retail investors owing to a preponderance of small-size transactions. Further analysis by JPMorgan researchers, however, revealed that many such transactions likely arose from algorithmic traders slicing up bigger orders to veil their strategies — a conclusion strategists at Nomura and RBC supported.

Other data similarly support the claim that institutional investors have been as active in stoking options-trading volumes as their retail counterparts. Volume in NDX Index Options, one of the most popular options contracts, for instance, rose 62% YoY among retail traders and 57% among the institutional cohort in 2023.

Moreover, growth in open interest underscores burgeoning activity across maturities. Average open interest in index options surged 15% last year. Open interest in NDX Index Options increased an even more robust 35% as investors reacted to the likely end of the Fed’s rate-hiking cycle by looking to trade further out on the term structure.

Professional traders have also increasingly woven options into their strategies. With forecast rate cuts dampening volatility, hedge funds have revived the short-vol trade that entails selling index put options to generate income. Another strategy growing in popularity involves collecting interest on the premium received from selling large volumes of deep in-the-money put options.

Quant trading desks at banks including Citigroup, JPMorgan, and UBS have meanwhile packaged 0DTE options into new and existing systematic products for clients.

“It’s not difficult to convince people that [options-based] solutions are actually superior in terms of risk management,” Citi Global Head of QIS Trading and Structuring Michele Cancelli told Bloomberg News. “That’s absolutely well accepted and can be the beginning of something that is going to expand further.”

Taken together, those trends suggest options-trading activity could prove stickier than previously thought due to flourishing institutional participation, driving growth in trading volumes for years to come.

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Expansion Drive

Hopes for continued volume growth have spurred an expansion drive among exchanges.

Leading U.S. options exchange Cboe, which rode the boom to record revenue last year, is focused on expanding its derivatives operation into Canada and Europe in 2024. The twin initiatives figure to boost volumes as overseas investors gain access to U.S. derivatives markets.

But the abrupt departure of longtime Cboe CEO Ed Tilly in September creates uncertainty around Cboe’s future path. At the same time, the exchange’s global expansion bid leaves it vulnerable to challengers eager to make market-share inroads in the U.S.

Nasdaq, the U.S.’s second-leading options exchange with a market share of more than 26%, aims to seize on that opportunity in part by relying on the NDX Index Options contract that is quickly growing into an options juggernaut. The Nasdaq-100 Index (NDX) has handily outperformed rival indices, returning 54% in 2023 to the S&P 500’s 24% and gaining 153% over the last five years to nearly double the S&P 500’s 81% return.

Prominently featuring technology companies while excluding financial firms, the NDX’s construction is arguably more representative of the 21st-century global economy than rival indices. NDX figures to see robust trading activity in 2024 as forecast rate cuts trim capital costs for high-growth tech firms and a cross-sector AI transformation gathers pace.

At almost $1.7M, the NDX Index Options contract also offers the largest notional exposure of any U.S.-listed contract, nearly four times more than the S&P 500’s corresponding contract and eight times that of the Russell 2000 Index. The NDX Index Options contract’s higher notional value makes it a cheaper tool for hedging stock-market bets than rival index options contracts.

For more information on Nasdaq’s suite of index options products, check out the Nasdaq-100® Index Options (NDX) page.

Like Nasdaq, several boutique U.S. equities exchanges are entering options trading in hopes of making their mark on the space. Low-cost exchange MEMX began offering options trading in late September and has so far captured a market share of around 1.6%.

MIAX, which already boasts a 16% share of U.S. options trading, plans to launch another options exchange, MIAX Sapphire, in Q2. It will feature taker-maker pricing, a price-time allocation model, and a physical trading floor due to open in Miami’s hip Wynwood neighborhood in H2.

The developments should foster healthy competition among exchanges that delivers value to investors in terms of both a greater breadth of offerings and enhanced marketplace efficiency, fueling further trading growth in a virtuous cycle.

Bright Future

Other tailwinds could likewise lift options-trading volumes in 2024.

A retail revival could be chief among them — particularly if retail investors trade their meme-stock enthusiasm for a more measured approach to hedging risk and generating income. Lessons learned from overzealous meme-stock forays, together with retail brokerages’ deepening efforts to educate individual investors on options-trading strategies and mechanics, should lubricate that process.

Another key driver of growth in options volume across maturities could spring from macro uncertainty surrounding central banks’ 2024 rate-cut path and looming U.S. elections.

With pundits predicting more modest stock-market gains in 2024, institutional investors could also ramp up their use of options to generate income by selling puts. Such activity would likely manifest in shorter-dated options more likely to expire unexercised.

Anticipating that use case, Nasdaq rolled out a series of new options contracts in November tracking popular ETFs that invest in gold, silver, natural gas, oil, and long-term Treasuries.

Because the new contracts expire on Wednesdays, they will also enable investors to hedge out risks associated with Fed meetings. Their popularity is a good bet given that ETF options already amount to 39% of all options contracts trading. Other exchanges could soon follow Nasdaq’s lead with similar products, industry executives told the Financial Times.

Wall Street’s biggest exchanges also collaborated last summer to reduce the post-IPO waiting period for trading options in a stock from four trading sessions to two for companies with a market capitalization of at least $3B.

The move could stoke options volumes if an anticipated IPO thaw materializes in 2024, helping retail and professional traders alike profit from stocks’ “often volatile infancy,” according to Bloomberg News. It also unlocks investor access to a wealth of options-related data including open interest, put/call ratios, implied shares to be sold, volatility zone triggers, and gamma tilt to aid in gauging market sentiment.

If you have questions regarding this essay or wish to connect with a member of the Nasdaq Options Team, please don’t hesitate to reach out to indexoptions@nasdaq.com.