Only 24% of institutional investor U.S. equity option volume is traded electronically, a stark contrast to fixed-income and FX derivatives. In addition, the buy side is also turning back to the OTC market to get their equity derivative orders filled despite a global push towards more exchange-like trading.

These are the conclusions of a new report, U.S. Equity Derivatives: Electronic Trading a Tough Sell for Investor, from Greenwich Associates.  These findings are based on interviews with 152 institutional portfolio managers and 197 institutional traders interviewed mid-year as part of the Greenwich Associates 2014 North American Equity Derivatives Study.

Asset Managers Prefer Specialized Contracts
Long-only asset managers traded more than half of their equity options bilaterally in 2014, compared to 42% one year earlier.  They have found it increasingly more efficient to have a broker create the exact contract they need, whether for hedging or taking a directional bet, than to work an order in the market over time. “Short of new regulations that limit this practice, the current ratio of OTC to exchange-traded will likely hold steady,” says Kevin McPartland, Head of Research for Market Structure and Technology at Greenwich Associates.

Opportunity for Brokers
While high-margin, high-touch trading will continue to dominate  for equity derivatives investors, an  opportunity exists for brokers focused on providing even more sophisticated trading tools to those buy-side firms looking to reduce fees, reduce implementation shortfall and hopefully increase alpha.

Options are a key product for managing and speculating on volatility, something that many institutional investors will need in the coming months and years.  New tools to facilitate more efficient trading of listed equity options brought to market as demand starts to increase will ultimately increase client adoption of electronic trading.

“Volatility is at historical lows and equity derivatives have continued to grow – a sign that a profitable market will only get more so in the next few,” says Greenwich Associates consultant John Colon.