New investment opportunities open through options on bond ETFs

Dan Barnes Welcome to ETF TV, I’m Dan Barnes. In the fixed income markets, exchange-traded funds become increasingly important for managing risk and liquidity. Today, we’re talking with Ashley Curtis, head of fixed income distribution for iShares EMEA at BlackRock, and Lee Bartholemew, global head of derivatives products R&D for fixed income at Eurex.

Deborah Fuhr And I’m Deborah from ETF TV. Today we’re discussing the growing number and use of options on ETFs. Welcome, Lee and Ashley.

Ashley Curtis Thanks, Deborah, for having us.

Lee Bartholomew Thanks for having us.

Dan Barnes What are the new fixed income ETF option products available in Eurex, Lee? And why have you launched them now?

Lee Bartholomew For us, it was a case of, ‘let’s think about trends that we see coming across in fixed income,’ and I think the growth in passive investment is here to stay in the long term. And you need to look at your product portfolio mix and see where you need to pivot and where you need to position for kind of the medium to long term. And ETF options is a natural extension for what we’re doing in terms of our true cross asset strategies. We now have listed across fixed income commodities and equities, 24 of the 26 iShares underlayings. So for us, it was looking at it holistically across the Eurex franchise, and saying how can we meet the demands from the end investor space? In the fixed income fx, we listed the dollar denominated fixed income underlaying on the high yield and corporate credits. We have US Treasury products out 20 years and we also have US dollar, emerging market debt. Within that as well we have the euro denominated equivalents.

Dan Barnes Ashley, what’s your view on the timing of these products?

Ashley Curtis I think the, why now, is a really good question. And there are probably a couple of reasons from my perspective as to why we’ve worked with Eurex on this. The obvious one is clients have asked for it, but more importantly, the overall ecosystem for ETFs and fixed income ETFs, in particular, is ready for it. The transparency we’ve got through MiFID II on ETF volumes has helped people get comfortable with fixed income ETF liquidity and therefore the options. Alongside that, the development of the securities lending market and the borrower market for fixed income ETFs has really improved, to the point where price makers have become comfortable that they can actually hedge their risk.

Dan Barnes Can you give us examples of a couple of use cases?

Ashley Curtis The first adopters are probably the asset managers, so both multi-asset and fundamental fixed income managers. But we’re also seeing interest from pension funds, insurance companies, hedge funds, and some private banks as well. The angle in the use case that each of these clients come from is slightly different. Fx asset managers or hedge funds who use CDS index options either for hedging or volatility strategies, they’ll see this as just a potential alternative. Equally, some of those investors who’ve already used the 40 act equivalents for the option side, they’re being pushed to use the UCITS equivalent, so we’re going to see some migration, I think. And insurance companies looking to reduce solvency to capital requirements on their ETF holdings by buying out of the money puts. Pension funds who have historically used a lot of equity index options for yield enhancement through selling out of the money calls, we expect them to look at this as an alternative to doing it in fixed income where they haven’t really been able to do it before. So there are quite a number of different clients that we expect to start using the product and in slightly different ways.

Deborah Fuhr And do you see a difference in the adoption of the use of options on ETFs in different countries across Europe?

Lee Bartholomew I wouldn’t say it’s a geographical, regional split. It’s more, I would say, by client type. Some of the more traditional asset managers have actually been quicker to adopt the products, and that’s come large now. I would say Central Europe.

Ashley Curtis The transition from clients who have used the US to the 40 Act ETF options, obviously those firms have been first to step into the UCITS space as well. And that’s predominantly been the asset managers.

Deborah Fuhr What do you see as the main benefits of options on ETFs in comparison to other alternative products?

Lee Bartholomew I think the driver of these use cases is more a function now of the cost to hedge. The product looks at it on a three-fold basis, so you’ve got listed vs OTC, you’ve then got replication of risk, and then you’ve got correlation to the benchmark. How can they use a multitude of products in order to better hedge their portfolio or create alpha via new avenues? And I think what you’re seeing with the electronification of markets, or a move to more standardized products which complements the OTC market is, the investors looking a lot more at what they can do in terms of reducing slippage, but also allowing some slippage on the tracking component, because it creates a more diverse ecosystem. So you have the non-bank liquidity providers which are comfortable providing liquidity in correlated products, right. Which is another reason why we’ve seeing that kind of an acceleration and pick up on the portfolio trading side. So they’re looking at putting that in parallel with other products that they want to use. And I think ETF options fits nicely within that segment.

Ashley Curtis The uses of CDS indices, we’ve seen a lot of clients moving to using ETFs, because they are more representative of what is already in their portfolios or the risk that they’re trying to hedge. It’s the same migration we’re starting to see in fixed income ETF options and CDS index options, that the performance is closer to underlying bond portfolios rather than having this basis between synthetic products and the cash product.

Dan Barnes And then, if I’m a portfolio manager or a buy-side trader and I’m thinking about how to include these products in the way I invest and trade, how are they viable in terms of the buy-side trading toolkit?

Lee Bartholomew The way we’ve set up the ETF options at Eurex right now is there’s a healthy balance between kind of screen liquidity and off-book liquidity. And I think by having the breadth of market makers that we have, that gives me comfort and end investors get the right depth through the levels, not just on top of the book.

Deborah Fuhr Thank you very much for joining us, Lee and Ashley, that was a very interesting conversation.

Ashley Curtis Thanks for having us.

Lee Bartholomew Thank you.

I’d like to thank Ashley, Lee and Deborah for their insights today and of course, you for watching. To catch up on our other shows or to subscribe to our newsletter, go to ETFTV.NET, or TRADERTV.NET.

Published on November 10, 2020