Goldman Retreats From Options as Stock Derivatives Trading Struggles

By Gunjan Banerji Features Dow Jones Newswires

Waning stock volatility is pressuring the equity derivatives business, suppressing revenue and driving traders out of what was once a key Wall Street moneymaker.

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Revenue in an equity derivatives business that focuses on listed options shrank by 41% in the U.S. and by 28% globally during the first half of 2017 from the same period a year ago, according to data firm Coalition, which tracked 12 of the biggest banks in the world. The number of employees in equity derivatives at banks has contracted by about 10% since 2012, Coalition data also show.

An extraordinary calm in markets has choked the trades that typically funnel through banks' derivatives desks. Banks like Deutsche Bank AG, Barclays Plc and J.P. Morgan Chase & Co. blamed lower revenues on depressed volatility when recently reporting earnings.

Goldman Sachs Group Inc. pulled back from U.S. options market-making on exchanges, a spokeswoman for the firm said Thursday. It's the latest to withdraw from the business of continuously buying and selling contracts on venues using automated programs.

The business isn't a large part of Goldman's overall equity derivatives revenue and the decision to retreat was driven by the high costs related to connecting to the many options exchanges, among other market structure issues, said a person familiar with the matter. The firm will still provide options services for clients, the spokeswoman said.

The number of equity derivatives contracts that have traded worldwide has dwindled since 2011, data from the World Federation of Exchanges show, as central banks worldwide propped up markets, damping investors' desire to use derivatives like options to hedge or protect holdings. Derivatives also face competition from quantitative trading, in which computers help develop strategies.

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"With lower volatility this year, we're seeing less of those trades come through," said Coalition's research director Amrit Shahani. "It's a vicious cycle."

OptionMetrics LLC founder David Hait said investors tend to think of options as insurance for stock bets.

With U.S. equities in an eight-year bull market, people are asking, "What do I need an option for?" he said.

The so-called flow equity derivatives business at banks can also include over-the-counter derivatives and swaps. Traders help research and execute trades using derivatives, while sales employees contact clients, such as hedge funds and pension funds, to suggest moves, collecting commissions when the trades are done.

The situation looks more dire for some banks. In the first half of 2017, revenue from Barclays's U.S. equity derivatives flow trading slumped to less than half of the $200 million it brought in the same period last year, according to a person with knowledge of the matter. Banks rarely break out this business from their equities broadly. Barclays declined to comment on the drop in revenue.

Analysts pressed Barclays in an October earnings call on why the firm underperformed peers in stocks. Chief Executive Jes Staley acknowledged that the bank was "surprised" by the decline in their flow equity derivatives business. A main area of underperformance in equities was in derivatives, said Barclays Group Finance Director Tushar Morzaria.

The decline was largely driven by its exposure to individual stocks, said the person familiar with the matter. Options bets on specific companies have been one of the hardest hit areas, as investors gravitate toward passive investments and algorithmic strategies. Trading individual U.S. stock options has fallen steadily since 2006 and is near its record low of 49% of total U.S. options volume, according to Tabb Group research through the third quarter.

Bright spots include trading on ETFs and indexes, which dominated U.S. options activity last quarter, Tabb data show. Structured products -- investment packages put together by banks that often include derivatives -- were also lucrative for some firms.

Equity derivatives account for a tiny slice of the derivatives held by U.S. banks, which held $2.9 trillion in notional amount as of the second quarter, compared with over $185 trillion across derivatives on assets including interest-rate products, data from the Office of the Comptroller of the Currency show.

After 16 years of trading options during which he ascended to managing director at Bank of America Corp. and Deutsche Bank, Zahid Biviji left Wall Street this year.

He cited fewer opportunities in the space, partly caused by regulations imposed after the financial crisis. He founded Wapanda, a phone app that will connect riders with taxis and ride-sharing services like Lyft.

"I had a good run making money," Mr. Biviji said, noting that "a lot of the derivatives business is in survival mode right now."

Some traders have pivoted to a less-regulated asset: cryptocurrencies.

"For the most part, you're not going to get wealthy like you could in the late '90s or early 2000s" in equity derivatives, said Arthur Hayes, the Hong Kong-based co-founder and chief of Bitcoin Mercantile Exchange, who traded derivatives at Citigroup Inc. and Deutsche Bank. "In cryptos, you actually get to do what you like to do: trade."

Write to Gunjan Banerji at Gunjan.Banerji@wsj.com

(END) Dow Jones Newswires

November 03, 2017 05:44 ET (09:44 GMT)