Sophisticated traders who have been using over-the-counter products and derivatives during times of heightened volatility are now utilizing alternative hedging products, such as complex exchange traded funds, as regulatory scrutiny ramps up.
More traders are beginning to use ETFs in place of options or futures in hedging strategies as regulators intensify their probe into derivatives, reports Telis Demos for the Financial Times.
“Hedge funds have been doing this for a long time. ETFs are a very liquid, quick way of putting a hedge on,” Briton Ryan, head of US ETF sales and trading at Newedge, said in the FT article.
However, Ryan notes that more large institutions, pension funds and foreign clients are now entering the U.S. ETF market, as well.
“If something happens in Europe and you know something’s going to happen in financials, you can put on a hedge quickly and cheaply when there’s high volatility and [therefore]a greater cost of hedging,” Ryan added.
According to the International Swaps and Derivatives Association, notional outstanding number of OTC derivatives has diminished 10% since 2009. The options market has expanded by less than 2% and most of that expansion may be attributed to options on ETFs, research firm Tabb Group said. [A Look at Recent Trends in ETF Options Trading]
Henry Chien, analyst at Tabb, points out that “ETF options have been a big source of options volume and now account for 37% of volume,” an increase of 39% year-over-year as of August 2011. [Short ETFs – These Funds Profit When Stocks Fall]
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.