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Galen Burghardt
Published 3/20/2008

Volume Surges Again

Global Futures and Options Trading Rises 28% in 2007

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The global volume numbers are once again astonishing. More than 15 billion futures and options contracts changed hands during 2007 on the 54 exchanges that report to the FIA, an increase of 28% from the previous year. That is a remarkable increase for any year, and what’s even more impressive is that the growth rate is actually accelerating.

Looking back at the last three years, the growth rates were 19% in 2006, 12% in 2005, and 9% in 2004. In fact, the last time we saw this much growth was in 2003, when volume jumped 30% from 6.2 billion to 8.1 billion. Given that most of the top contracts have been around for years, if not decades, it is remarkable that we are still finding so much room to grow.

There is no guarantee, of course, that this trend will continue. Trading volume tends to ebb and flow in unpredictable ways, and the current wave of growth may well subside. The good news is that volume levels are rising almost everywhere we look, and that speaks well to the longterm health of our industry.

First, the upward trends we are seeing are taking place across all segments of the exchangetraded marketplace. Equity futures and options, both index and single stock, are unquestionably the most powerful drivers of growth. On a combined basis, equity products accounted for a whopping 64% of the total volume last year, and more than 71% of the total increase in volume. One big factor was the sharp increase in volatility in the second half of the year, a subject that I will return to later in this article.

Interest rate futures and options trading grew by 17%, a very healthy rate in historical terms, but somewhat behind this year’s overall average of 28%. Commodity products, on the other hand, had a burst of growth in 2007, helped by the greater adoption of electronic trading, the boom in biofuels, and stronger interest among institutional investors. Agricultural futures and options trading grew by 32%, energy by 28.6%, and industrial metals by 29.7%. The only real laggard was the precious metals segment, where higher volume in New York was partially offset by declining volume in Tokyo.

Second, growth is taking place across all regions of the exchange traded marketplace. As the global brokers well know, this business is no longer concentrated in the major European and North American centers. China, though still largely closed to foreign participants, is a huge force in agricultural and metals futures trading. The National Stock Exchange of India continues to move up the top exchange list, and Hong Kong Exchanges and Clearing more than doubled its volume last year.

Elsewhere in Asia, the Korea Exchange had one of its best years in recent memory. Total volume grew by 9.5%, below the global average, but quite an improvement from last year’s 4.6% decline and the previous year’s 11.2% decline. Given the enormous amount of trading in the Korean market, even a low rate of growth in percentage terms has a big effect on the overall volume trend.

The Chinese exchanges saw some especially pronounced swings in volume. The Dalian Commodity Exchange’s corn futures contract, which tripled in volume last year and became the second most actively traded agricultural futures contract in the world, reversed direction and lost some ground in 2007, with volume falling 12% to 59.4 million contracts. A similar situation emerged in the aluminum futures market, with the Shanghai Futures Exchange’s contract crashing by 65% to 4.8 million. On the other hand, the SHFE’s new zinc futures contract, which began trading at the end of March, immediately caught fire, with total volume reaching 10.2 million contracts by the end of the year.

Perhaps the most surprising story of 2007, at least from a geographical perspective, was the astonishing burst of volume at JSE, the South African futures and options exchange. Volume on that exchange skyrocketed 214% to 329.6 million contracts, driven mainly by an explosion of trading in its single stock futures contracts. Another up and coming market is the Turkish Derivatives Exchange, which saw volume rise by an extraordinary rate of 263% to almost 24.9 million. We also saw tremendous growth in Brazil. BM&F jumped 50% to 426.4 million contracts, while Bovespa rose 28% to 367.7 million contracts. And a little farther south, the Rosario exchange in Argentina rose 40% to 25.4 million contracts.

Stepping back from the individual exchange level, it is interesting to look at a breakdown of the global volume total by region. The Asia Pacific region accounted for 28% of all futures and options traded on exchanges worldwide in 2007, versus just 22% for Europe. It is important to remember that much of the trading in Asia is conducted in contracts with relatively small notional values, such as the Kospi 200 index options. Nevertheless, it is obvious from this simple comparison why so many people in our industry are looking east. Many of those markets are still finding their legs, and the growth of trading, as the exchanges continue to list new contracts, and risk management becomes more common, is likely to be one of the biggest volume drivers for many years to come.

Exchange Consolidation
Amid all the attention to what we used to call the Third World, it is easy to lose sight of what happened in the birthplace of the modern futures industry. North America in general, and Chicago in particular, had an extraordinary year in 2007. More than 6.1 billion futures and options changed hands in North America in 2007, an increase of 33% over the previous year. In other words, North America is not only the largest region in the world in terms of trading activity, it is also growing the most rapidly.

2007 is also the year when consolidation really had an impact on our volume tables. The Chicago Mercantile Exchange and the Chicago Board of Trade, now combined into a single company, grew by 27%, a remarkable achievement for an exchange whose principal products have been around for so many years. Even more remarkable, CME Group has now pulled ahead of the Korea Exchange as the world’s largest derivatives exchange, with combined volume of 2.8 billion contracts versus Korea’s 2.7 billion contracts. A few years ago Korea had such a huge lead it seemed like no one would ever catch up. The fact that CME managed to do just that reflects the continuing appeal of its core products as well as the wave of mergers and acquisitions that is transforming the exchange landscape worldwide.

To show the effect that this consolidation trend is having, we have created a table showing the volume totals for several large exchange groups and the various subsidiary exchanges within the group. This includes not only the CME Group but also IntercontinentalExchange, which now owns three exchanges in three separate countries; Eurex, which now owns one of the biggest equity options marketplaces in the U.S.; OMX, which operates a whole raft of derivatives markets across Northern Europe; and NYSE Euronext, which has five European derivatives markets under its Liffe umbrella in addition to NYSE Arca Options, the most rapidly growing equity options exchange. In some cases, these subsidiary exchanges are still run as separate enterprises, but over time we are likely to see greater and greater integration as the parent companies take advantage of the obvious synergies in technology and market access.

The other amazing story in North America was the extraordinary growth of options trading. Total volume on the six U.S. options exchanges rose by 41% to 2.86 billion. To put that into perspective, the difference in volume for these six exchanges between 2007 and 2006 was 835 million contracts, which was almost the same amount as all of the trading in China and India combined. Nowhere else among the mature markets of Europe and North America did we see such strong growth. In comparison, volume on the U.S. futures exchanges grew by 27% to 3.2 billion contracts, and volume on the European derivatives exchanges grew by 25% to 3.35 billion contracts. Those are both tremendous numbers, but they don’t come close to matching the 41% growth rate in equity options, which appears to be driven by a transformation in the way institutional investors view these products as well as the sharp increase in volatility alluded to earlier.

Volume Isn’t Everything
While the overall rate of growth was remarkably high, it is worth noting that there were a handful of big contracts that did not do so well in 2007. The TIIE 28, the short term interest rate futures traded at the Mexican Derivatives Exchange, has been a huge success for a number of years, but last year volume slipped 16% to 220.6 million contracts. One reason may have been that market participants shifted some of their activity to a newly introduced 10year interest rate swap futures contract that offers better hedging of long term risk exposures. The new swap futures contract is 10 times the size of the TIIE 28 contract, making it more suitable for the institutional players active in the peso swap market. And it allows hedgers to use just one instrument rather than a whole strip of one month contracts. So while the exchange may undergo a decline in volume as users trade fewer packs and bundles of the TIIE 28 contract, Mexder’s value as a marketplace for hedging interestrate risk can only be enhanced if the new swap futures contract proves to be a hit.

One of the best examples of a successful introduction of a new contract was the Chicago Board Options Exchange’s determined efforts to promote its Vix options, which are based on the exchange’s well known equity volatility index. This contract was launched in February 2006 and achieved only modest volume in its first year, but the hard work paid off in 2007. Volume reached 23.4 million contracts, up by 363% from the previous year. That may not sound like a lot compared to the benchmark equity index contracts, which trade in the hundreds of millions of contracts, but it’s pretty good for something this novel. This often seems to be the pattern with the really innovative contracts: a period of obscurity while market participants become accustomed to the new contract and its uses, and then slowly momentum starts to build.

This year’s volume statistics were gathered from 63 exchanges that voluntarily provided data to the FIA. In most cases, such as ASX, CBOE, CME Group, Liffe, ICE and OMX, the FIA consolidates the data from affiliated exchanges and publishes one set of numbers for the group as a whole. As a result, the number of exchanges listed in the volume rankings was reduced from 63 to 54.

There were two exceptions, however, where the FIA did not consolidate data from affiliated exchanges. In the case of NYSE Arca and Liffe, both of which are now part of the NYSE Euronext group, the FIA’s view was that these two exchanges have been operating in such different environments that it makes more sense to treat them separately, at least for the purposes of this report. In the case of the International Securities Exchange and Eurex, the merger of those two exchanges was not completed until the end of 2007, so they are still treated as separate entities for the two years covered by this report.

Volatility Patterns and the Impact on Trading Costs
It is tempting for someone writing from my perspective in the U.S. to think that the second half of 2007 was exceptionally volatile. It was in fact more volatile in U.S. equity and bond markets, but two things are worth noting. First, other markets did not experience the same increase in volatility. S&P 500 volatility increased from 9.7% in 2006 to 15.9% in 2007, but Euro Stoxx 50 volatility only increased from 14.4% to 15.5%, and Topix volatility from 18.9% to 20.6%. Ten year Treasury note volatility increased from 3.8% in 2006 to 5.2% in 2007, but Bund volatility only increased from 3.8% to 4.1%, while Japan Government Bond volatility actually fell.

Second, the increase in volatility in the U.S. was from levels that were lower than any we had seen for 10 years or more. We used to think that 15% volatility for S&P 500 products was normal. So in some sense, what happened in 2007 was not much more than a reversion to levels that we used to see all the time. In other markets the volatility picture was mixed. The volatility of the Euro and the British pound both fell, while yen volatility increased slightly. Crude oil volatility was up, but natural gas volatility fell. Wheat and corn volatilities rose, while copper and aluminum volatilities fell. While some may welcome the increase in volatility as a driver of volume, we need to be aware of the effect that this volatility has on execution costs. All of the research we have done on market impact suggests that a doubling of price volatility requires a quadrupling of trading volume to compensate in terms of keeping the trading cost per contract at the same level. What we find instead is that trading volumes tend to increase relatively less than price volatility. In equity index futures, for example, our rule of thumb is that a 100% increase in price volatility is accompanied by only a 50% increase in trading volume. As a result, periods of higher price volatility tend to be periods of higher market impact or, what means the same thing, lower market liquidity. This is exactly what happened in 2007. One measure of the cost of trading is the implied bid/ask spread. In those markets where volatility increased significantly, such as Emini S&P 500 futures and 10year Treasury note futures, we saw an increase in the implied bid/ask spreads. And in those markets where volatility increased only moderately or not at all, such as Euros, Bunds and the Euro Stoxx 50, we saw that the spreads stayed roughly constant (see chart below, “Index of Implied Bid/Ask Spreads”).

The Particular Case of Equity Index Futures
“Liquidity is really poor now,” is a complaint one hears in equity markets. The truth of the complaint depends in part on which market one is talking about and the standard of comparison. Consider what happened to the sweep-tofill cost of filling a 1,000-lot order in E-mini S&P futures. Over the first half of the year, the average impact when measured against true market price (a weighted average of the bid and ask prices) was in the neighborhood of 0.25 index points. During the second half of the year, the impact for much of the time was in the neighborhood of 0.35 index points, although there were times when the cost of filling such an order was much higher for short periods of time. In contrast, the sweepto- fill cost of filling a 1,000-lot order in Euro Stoxx 50 futures was between 1 and 1.5 index points for most of the year.

For U.S. equity index traders, the statement rings true if their standard of comparison was the liquidity they had enjoyed before volatility rose in U.S. equity markets in the second half of 2007. For European equity index traders, if the costs of trading have risen, the rise has been very slight. By another standard, however, the liquidity in these markets compares very favorably with what one would find in corresponding cash markets. A market impact of 0.35 index points for a 1,000-lot order in E-mini S&P futures represents an impact of 0.026%. A market impact of 1.25 index points for a 1,000-lot order in Euro Stoxx 50 futures represents an impact of 0.034%. When compared with the instantaneous cost of trading roughly $70 million in a basket of U.S. stocks, 0.026% would be relatively small. When compared with trading roughly $60 million in a basket of European stocks, 0.034% would be very small indeed. We have argued that one can understand market liquidity and market impact using a very simple model that combines price volatility and trading volume. To show how well this insight works, we have overlaid two series in the chart (left) “Market Impact, Volume, and Volatility. ”One is the sweep-to fill impact for a 1,000-lot order in E-mini S&P futures. The other is simply the ratio of relative price volatility to the square root of trading volume.

As the chart shows, the two series track each other very closely. In our view, this really drives home the point made above that volatility tends to increase the cost of trading and create the perception of declining liquidity even as volume is rising.

futures growth over past four years
Global Exchange-Traded erivatives Volume
Note: based on the number of futures and options traded and/or cleared by 54 exchanges worldwide
Volume by Region
*Note based on the number of futures and options traded and/or cleared by 54 exchanges worldwide
%by region
*Note:Based on the number of futures and options traded and/or cleared by 54 exchanges worldwide.
Top dirivities worldwide
*Note ranking does not include exchanges that do not report their volume to the FIA. Exhange under common ownership or grouped together. See exchange group table for breakdown of volume by affiliated exchanges.
Exchange Groups
20 Interest Rate Futures and Options Worldwide
Top 20 Equity Index Futures and Options Worldwide
Top 20 Energy Futures and Options Worldwide
*Traded primarily off-exchange
Top 20 Agricultural Futures and Options Worldwide
Top 20 Metals Futures and Options Worldwide
*Not listed for trading in 2006
Source: Newedge Group
Market Impact Volume, and Volatility
Source: Newedge Group
Index of Implied Bid/Ask Spreads
Source: Newedge Group
Galen Burghardt is research director for Coex Partners, a division of ED&F Man Capital Markets.
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