During his recent interview with Tobias, Benn Eifert, CIO at QVR Advisors, discusses options trading strategies and why investors should avoid options in single names. Here’s an excerpt from the interview:
Tobias Carlisle: You find that there’s sufficient liquidity in the options, enlisted options, even in single names, to put those trades on?
Benn Eifert: Liquidity in, I would make a couple of distinctions of what we mean. On primarily what we do, we’re more index-focused than we are single-name focused. I think typically, the types of risks that a large institution is worried about from a tail-risk perspective in particular, are usually broad macro events. They’re not usually specifically trying to hedge individual equity exposures that they have, or if they do, that’s again just a very specific thing. We tend to live more in index, region, sector type of exposures.
Benn Eifert: Liquidity in general in the option markets, I think index has in our view, certainly volumes have increased and increased and increased very steadily every year for the last many years in index. Whereas, that wouldn’t be the case really in single-name options. In a single-name, option volumes have somewhat stagnated or at least grown not nearly as quickly as index. There’s a variety of reasons for that.
Tobias Carlisle: What are those reasons?
Benn Eifert: You have to think of ultimately the primary market makers in options are going to be the broker dealers and also the major electronic option market makers like Citadel and like Walleye, and various other folks. Those folks are trying to solve a pretty specific risk-management problem when they’re doing business, which is they want to do less of volume with some edge in that they’re making bids and offers and people are paying them some spread that covers some of the risk that they get into a position that moves against them.
Benn Eifert: In single-names, the toxicity risk of flow is higher because people lift you on those nickel calls, on some funny company right before earnings, and just a symmetry of information is a much worse problem for a dealer. In the I would say 10 or 15 years ago banks and other organizations involved in market making were just making money hand over fist in everything that they were doing. When things are going that well, you can be aggressive across a variety of business lines that maybe aren’t as profitable for you, and just as part of an overall business. I think that’s why banks were more aggressive say even in 2008 or 2007 on some single-name related things.
Benn Eifert: Whereas index, you don’t have nearly the same asymmetric information problem, right? S&P options, for the most part, there really aren’t events in special situations of a very, very major variety. Obviously, there’s fed releases and there’s certain kinds of discrete moments when information becomes available that someone might’ve gotten a hold of. It’s just a much smaller adverse selection problem for market makers. I think that’s what’s really bifurcated the liquidity there.
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