Options Trading Volume Dropped 10.5 Percent Over August '07, Marking First Decline in Five Years

While equity options trading volume always seems to go up, last month the tide turned when the equity options industry saw more than a 10 percent decline in volume after 61 months of straight increases.

According to the Options Industry Council, total options trading volume in August was 263.4 million contracts, marking a decline of 10.5 percent from the record-breaking 294.2 million contracts traded last August when market volatility surged from the credit crisis.

This represents the first decline in monthly volume from the year-ago period to occur since 2003, reported the OIC. In other words, options trading volume has been steadily increasing for the past 61 months (more than five years) until last week. "This is absolutely noteworthy that we had a month that it didn't go up," comments Jim Binder, a spokesman for the OIC.

Though August is traditionally a slow month, Binder points out that the industry had an "incredible month last August. It was a huge volume because of what was going on in the stock markets," he says.

With hedge funds selling off their equity positions to raise cash to meet margin calls from structured products a year ago, investors turned to the options markets. "There was speculation and there was absolutely hedging going on," says Binder. Investors that found themselves exposed to a deepening crisis last year figured they had to give themselves some protection in options, he suggests.

Though the options market was growing for years with historically lower volatility, notes Binder, "When you threw this increased volatility onto an already growing market, it took off," says the OIC spokesman. In terms of analyzing the reasons for the decline, the exchanges had two more trading days last year than they did for August of 2008. That took out about 250,000 contracts from average daily trading volume, he estimates. This year, the average daily volume was 12.5 million contracts vs. 12.8 million contracts traded last year. "All of a sudden that 10.5 percent trading volume drop is much less when you look at it through the average daily trading volume," says Blinder.

The OIC spokesman suggests that the decline is less meaningful than it looks. Equity options volume saw 241.6 million contracts change hands, which is a decrease of 7.7 percent from August of 2007. This decline was less than the 10.5 percent. Meanwhile, equity options average daily volume " rose 1.2 percent over August 2007. That includes single stock options as well as options on ETFs (exchange traded funds).

"Even though there were two fewer days of trading, you had an increase in average daily volume in equity options," notes Binder. What this means is that compared to last August, there was a dip in index option trading, explains Binder. Since the average daily volume was higher than last year, it shows that the decrease really did come out of the index options, says Binder.

Eventually this was something that was going to happen, observes Binder. "This is not to say the sky is falling in options and they're no longer popular," he says. Even with this August decline, the year-to-date options volume stands at 2.37 billion contracts, up 30 percent over the same period in 2007. But is this August decline a harbinger of a down year? Options volume would need to drop to between three-and -five million contracts per day for the rest of the year, to keep the industry from having a record year, he says. That's unlikely. Yesterday, average daily volume in options was 13 million contracts and even in the slow month of August, volume was 8 million contracts a day.

"I don't see that happening," says Binder, who predicts the options market will break last year's volume record in October. "I'm confident we will break last year's record and get to 3 billion contracts," he says.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio