Interaction of Cash & Derivatives Markets

WFE Workshop on Market Structure & Statistics December 2, 2008

William Speth, Director of Research Chicago Board Options Exchange

S. Perspective   Trading technology & market structure merging Regulation & Clearing Derivatives as a cash market: VIX futures & options .Overview  A U.

  ontra t Volume ¡ 10 000 000 15 000 000 20 000 000 25 000 000 30 000 000 35 000 000 40 000 000 45 000 000 50 000 000 5 000 000 0 SPY Options Volume Takes Off in 2007 SPY SPX ja n m -0 6 ar s0 m 6 ai -0 ju 6 ilse 06 pt -0 no 6 j a 06 n m -0 7 ar s0 m 7 ai -0 ju 7 ilse 07 pt -0 no 7 j a 07 n m -0 8 ar s0 m 8 ai -0 ju 8 ilse 08 pt -0 no 8 -0 8 .

Growth in ETF Options Mirrors SPY 160 000 000 140 000 000 o ume ontr 120 000 000 100 000 000 80 000 000 60 000 000 40 000 000 20 000 000 0 6 rs -0 m 6 i0 ju 6 ise 06 pt -0 no 6 -0 j 6 n m -0 7 rs -0 m 7 i0 ju 7 ise 07 pt -0 no 7 -0 j 7 n m -0 8 rs -0 m 8 i0 ju 8 ise 08 pt -0 no 8 -0 8 A SH IN EX ETF n j m -0 ¨ § ¤£ t ¦ ¥ ¢ .

/Retail split Tight spreads. computing technology . lots of traders NonNon-traditional liquidity providers Heavy use of high frequency data. true size rarely top of book.Program Trading in Derivatives       Electronic Markets Better Trading Systems cash & derivative Penny pricing Inst. liquid markets.

Program Trading in Options  Major Issues Latency Market Model Payment vs. Maker/Taker Fragmentation / Linkage   CBOE plans to launch C2 Projected to be 40% or more by 2010 .

Dark Pools / Fragmentation? .What s  ext? Broker dealings with customers. etc. listed & OTC options Tied / Delta-neutral Trades Delta Directed trades  Customer directs broker on order execution or execution of stock delta hedge   Benchmark Trades VWAP.

Dealer vs. Listed. Clearinghouse SEC vs. but see writing on the wall Margin requirements will be an issue OTC activity to exchanges? .Regulation & Clearing  Issues facing cash & derivatives markets OTC vs. CFTC Short Sale Restrictions impact on volatility Market Maker Exemptions Less leverage / Lower volumes  New OTC Market Regulation Counterparty concerns / Transparency / Risk Dealers reluctant.

DTCC Futures Clearing  Need some form of common clearing / crosscross-margining to increase capital efficiency of listed markets . derivatives and cash products cleared at separate clearing houses Options Clearing Corp.Regulation & Clearing  In US.

Options in 2006 Index priced using option SPX options VIX derivative spreads much narrower (order of magnitude) than equivalent cash market spreads Settlement of VIX contracts based on opening auction prices of SPX options 120 to 150 series Opening auction generates 200K to 400K SPX option volume  .Derivatives    The ew Cash VIX Futures & Options New VIX introduced in 2003. VIX futures in 2004.