Dash Financial Technologies is an options and equities electronic-trading technology provider.
A surge on Wall Street stock-trading desks is being driven by manic investor moves in derivatives, as fund managers scramble to protect their gains from future volatility.
Following a leap in stock market gyrations so far this year, the biggest U.S. banks generated more revenue from stock trading than in any first quarter since the financial crisis, according to a Wall Street Journal analysis of bank regulatory filings.
It’s been a long time coming. The business of trading is still far from its precrisis peak, when fewer trades were done electronically and overall fees charged by banks were higher. Now, more trades are done automatically, leaving razor-thin margins for traders. And while activity has had ups and downs, it’s been muted in recent years due to low interest rates and sagging volatility.
This past quarter, however, volatility returned and derivatives such as stock-index futures and options picked up along with activity in exchange-traded funds, which also reside in banks’ stock-trading, or equities, departments.
Overall, U.S. options trading enjoyed its busiest quarter in history, by one measure, according to research from consulting firm Tabb Group and data provider Hanweck. Nearly 1.4 billion options contracts were cleared in the first quarter, up 33% from a year ago, the firms said.
“Some days, it was like nothing I’ve ever seen before,” said Peter Maragos, chief executive of Dash Financial Technologies, an options and equities electronic-trading technology provider.
Only a small portion of the revenue upswing came from the buying and selling of actual shares in companies, according to bank trading executives. Instead, the biggest gains grew out of clients such as mutual funds, hedge funds and pension portfolios trading stock derivatives, with some investors aiming to hedge their positions and others speculating on more big swings.
If the volatility remains elevated and clients stay active, moving their money to take advantage of new opportunities, “you could see this revenue level for the next three quarters” at banks, predicts Guy Moszkowski, analyst at Autonomous Research.
But recent trends suggest that many fund managers won’t necessarily be looking to put more money to work in the market if prices drop. In a volatile market, banks also face elevated risks that they could be caught on the wrong side of a trade.
“Everyone in equities is now thinking about preparing and taking on more insurance,” said Brad Bailey, research director at Celent, which advises financial firms on technology.
Derivatives contracts, which can tie to any instrument from stock indexes to interest rates, have a long and colorful history on Wall Street, generating lucrative paydays but also painful losses due in part to the ease with which they can be used with borrowed money.
The biggest banks, in particular, have seen ups and downs in equities, including more than $1 billion in losses last year tied to the former chairman of South African retailer Steinhoff International .
In the first quarter, equities trading revenue at the five biggest Wall Street banks— Morgan Stanley, Goldman Sachs, JPMorgan Chase, Bank of America and Citigroup —was $9.5 billion, the largest haul for those firms since at least 2009, according to the Journal analysis.
The 32% jump from last year’s first quarter was the biggest since 2011, and far greater than analysts anticipated. Switzerland’s UBS Group, which is also a large U.S. equities trading firm, reported Monday a nearly 25% jump in first-quarter equities trading revenue, as measured in dollars, from a year earlier.
Driving the jump was equity derivatives; revenue at some banks in that department rose by more than 50%, people familiar with the matter said. Meanwhile, actual stock trading, known as “cash trading” in Wall Street parlance, was generally up only a small amount from a year ago, the people said.
The results helped make up for a slight dip in performance among those banks’ larger fixed-income, commodities and currencies desks.
Morgan Stanley Chief Financial Officer Jonathan Pruzan said equity-derivatives trading was “the highlight” of the quarter, in which the bank’s equities revenue rose 27%.
Banks’ equity-derivatives units span a mix of complex products that are designed to pay off when stock or fund prices move, according to Coalition, a research firm tracking banks.
The business had been hurt by low volatility over the past two years. Revenue in equity derivatives fell by more than 25% across the 12 largest global banks from 2015 to 2017, Coalition noted.
Then, stock-market volatility returned, with the Cboe Volatility Index, or VIX, surging well above 20 during the quarter, up from single-digits much of last year. In fact, one of the hottest areas in derivatives tied to stocks are bets on volatility.
Big banks’ trading desks benefited in particular as large investment firms—their key clients, as opposed to retail investors or high-speed trading firms—increasingly sought derivatives to hedge against sharp market moves, according to senior equities executives at large banks.
Meanwhile, the same volatility kept many stock buyers away from the market. More than $15 billion flowed out of stock-based mutual funds on a net basis during the first two months of the year, about four times 2017’s level, according to the Investment Company Institute.
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