Citi feeling at home with acceleration of electronic options
When it comes to electronic options trading, few match the experience of Don Kuster, a managing director for Citigroup Fixed Income Capital Markets, who has been at the forefront of the electronically traded options business at CME and other markets.
“There's been an explosion of options volume from the floor to the screen, where you have an open and transparent market and can access it anonymously,” says Kuster. “Three years ago, the options volume on the screen was zero. As things have moved to point-andclick and algorithmic trading, you now know what the price is in real time and can make decisions based on that – all big steps forward for the marketplace.”
Kuster has been making markets in options, primarily fixed income, for almost 20 years. He joined the Arbitrade trading group in 1997, which targeted electronic options markets in fixed income, equity indexes and currencies, and that company subsequently was purchased by Citigroup in 2004.
“Our focus in the '90s was that the future would be in electronic trading,” Kuster says. “We believed it was going to be a high-growth industry, and thought that the advantages that come with electronic trading – anonymity, transparency and liquidity for the customer, coupled with continued financial product literacy in general – would translate into an explosion in derivatives trading. This has proven to be true.”
As a market maker for Citigroup in Minnetonka, Minn., Kuster has watched CME Eurodollar options make major strides on the screen. During the first quarter of 2007, electronic CME Eurodollar options volume almost doubled, with an average daily volume of 93,000 contracts per day, up sharply from 52,000 contracts per day a year earlier. Total electronic options volume, which include equity index, currency and commodity options, continue to grow as well, with 158,000 contracts traded per day in April, up 46 percent from the same period a year ago, and accounting for a record 14 percent of total CME options volume.
As options markets have grown and become more electronic, Kuster has seen spreads narrow and competition among market makers intensify. He says margins on electronically traded options have narrowed 50 percent over the past three years.
“We believe that will continue,” Kuster says of margins. “But we still think we can be profitable as a market maker in that scenario. The much lower margins are offset by the increased volumes. Overall, it's great for the CME customer. I, and any other market maker, have to show best price at all times, in good size, to have a chance to trade.”
Citigroup's Minnesota operation was one of the original CME members to make markets electronically in CME Eurodollar, currency and index options. As electronic options take a larger share of the market today, the user base has opened up to institutional players such as proprietary trading firms, hedge funds, banks and other end users that want electronic access to the markets. Kuster believes this customer base will eventually propel electronic options to become more prominent financial tools than they have been in the past.
“One of the more interesting developments over the next two or three years will be in the institutional options space,” Kuster says. “You have the CME S&P 500 and Eurodollar options, which are really for the institutional space. Within these product groups, you have a lot of spread trading. The build-out of electronic spread trading for institutions is in its infancy. As customer familiarity and comfort with electronic spread trading increases, I expect to see more options volume migrate to CME Globex.”
Kuster believes that CME's options markets, with their transparency and liquidity, will continue to surpass the European options markets in terms of growth.
“We don't see a centralized marketplace in Europe. Europe's OTC-type model we believe hurts liquidity and transparency and lacks anonymity,” Kuster says. “What will be interesting in the next few years is to see whether the United States can develop an electronic institutional marketplace that gives point-and-click ability to customers. If CME can follow that model as opposed to the OTC-type of market we encounter in Europe, we see the CME's volumes growing at a faster rate than that of Europe's exchanges.”
CME has been doing its part in developing electronic options by introducing more trading functionality, providing and enabling users with anonymity and enabling the simultaneous distribution of every electronic request for quote (eRFQ) to all participants simultaneously. All trade confirmations are also broadcast systemwide simultaneously, and the platform provides instant trade confirmations, straight-through-processing and automatic linkage to risk management systems.
Last summer, CME introduced electronic covered options – or “covereds” – which are option instruments created by combining a CME-defined outright option or option spread with one or two underlying CME Eurodollar futures. They are well suited for traders who commonly use volatility strategies to trade CME Eurodollar futures and options, and also can be used to improve prices. In March, CME launched the second phase of user-defined spreads. CME Globex support user-defined spreads, which allow traders to create a spread if CME doesn't already offer it. The increased functionality makes it possible to create, request quotes on and trade unique options spreads that are not pre-defined on CME Globex. CME also introduced user-defined spreads to complement roughly 30 predefined strategies. CME also introduced its EOS Trader front end in March, an Internet-based system that offers a strategy builder. Such functionality works well for a market-maker group such as Citigroup because the more flexibility that is offered to customers, the more the markets continue to attract new users.
Recently, the growing attractiveness of the CME platform convinced Kuster to support the CME's electronic currency options.
“Foreign exchange is a huge marketplace,” Kuster says. “For generic options volatility, CME is going to be a viable alternative to OTC. We think there will be enough liquidity out there for customers to make CME a significant player in the marketplace in the future. The challenge for CME in the currency space is enticing customers to take another look at CME for currency needs.”
http://www.citigroup.com/citi/fixedincome/