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Montréal Exchange: Maintaining Momentum In Canadian Equity Options Trading

Dec 14, 2022

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The equity derivatives markets in 2022 presented a very different backdrop than the previous year. The two years of the pandemic prior were a period of low interest rates and average volatility. The year started with resilient growth, but the trend reversed after the first quarter with high inflation and hawkish monetary policies.

As interest rates and volatility rose, new types of structured products entered the market to attract retail investors while balancing institutional investors’ needs. At the same time, buy-side investing contributed to trading volumes of equity and index derivatives products, such as equity options and covered call ETFs.


Retrospective on Canadian Equity Derivatives

Global geopolitical tensions and supply chain constraints created positive momentum in some industries and a downtrend market in others. In Canada, natural resources and other commodities-based sectors pushed stock prices up, while financial services and real estate held steady in a shifting economic environment.

This past year also indicated good momentum for Canadian equity derivatives buoyed by strong institutional participation and growing retail interest. At the time of writing this article, the year-to-date volumes for equity options on Montréal Exchange (MX) increased by 18.6% and rose by 43.1% for ETF options (as of November 30, 2022).

MX tapped into investor interest by launching six sector index futures in the second quarter of this year, focusing on energy, financial services, insurance, media, telecommunications, and real estate. These funds are structured as Total Return Futures (TRF) contracts and are, therefore, different from existing sector index futures. They offer all the benefits of trading futures, such as hedging risk, lower margins, efficient use of capital, portfolio diversification, and exposure to Canada’s top-performing sectors.

Covered call ETFs are another type of investment product that has attracted strong interest from institutional and retail investors, with liquidity support from market makers. In Canada alone, there has been significant activity in the exchange-traded fund space, with approximately $16 billion issued across 98 covered call and put writing ETFs in the banking, resource and energy sectors. Investors can trade more than 50 ETF options on MX that provide exposure to high-growth, niche sectors, including Bitcoin and Ether.


Improvements to Canadian Derivatives Trading

Market dynamics are continuously evolving along with the needs of the investor community. Volatility is expected to be the main theme of 2023, along with slower growth and monetary policy uncertainty. In this environment, it is especially critical for MX to align our processes and product offerings to market trends and investor demands. Our objectives at MX are two-fold: position Canadian listed derivatives as a high-value addition to any investment portfolio and make it easier for investors to gain exposure to Canada’s growth sectors through targeted options and futures trading strategies.

The Canadian regulatory environment is favorable to product innovation and facilitating the launch of new investment vehicles faster than other regimes. The team at MX has worked with clients, market participants and market makers over the last few years to understand future trends and make strategic investments, including developing new derivative offerings and modernizing existing futures and options. These efforts are paying off with more sustained liquidity and an upward growth trend in equity options trading.

We recognize that the current macro conditions and fast-paced trading environment require a more dynamic and nimble investment approach. We have heard from investors and traders that MX’s internal processes need to be retooled for efficiency and speed in executing various order types, particularly at the close. With the introduction of stricter equity and ETF options market making obligations last May, options quotes are significantly tighter than in the past. That being said, we also know that there is still room to improve the two-way screen market and bridge the retail and institutional flow gap.

We’re continuing to have ongoing consultations with the industry and our clients that will inform our focus for the next few years. One of the initiatives we are exploring includes automation to create operational efficiencies within our systems, processes and people. In addition, we’re planning to introduce a guaranteed cross-price improvement auction for equity and ETF options and organize the market structure for greater price transparency and fairness in executing order types.

At MX, we have been on a journey for several years to modernize the Canadian listed derivatives marketplace and offer diversification for domestic and global investors. Through MX, investors can access niche sectors in Canada, such as Ether, Bitcoin and cannabis, as well as growth engines like energy and financial services.

As we look ahead to 2023, our plan is to continue gathering feedback from our clients and collaborating with market participants to drive retail and institutional interest in Canadian markets and grow liquidity.

Etienne Ménard is head of product, equity derivatives at Montréal Exchange.

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