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Montréal Exchange: The Rise Of Retail Investing In Canadian Derivatives

Sep 27, 2022

This independent content is made possible by TMX

The marketplace dynamic is changing with the emergence of a new class of individual investors with distinctive behaviors, motivations and financial objectives as well as varying levels of risk tolerance. While the headlines in recent years have focused on meme stocks, retail investors are trading derivatives, particularly in options.

In markets such as the United States, retail trading accounts for almost as much volume as mutual funds and hedge funds combined. Retail investors helped the U.S. options trading volumes reach new heights during the pandemic. While other countries, including Canada, have seen varying degrees of retail activity in recent years, based on what we see in the market, retail investors are likely to remain active for the foreseeable future.

Factors Contributing To Retail Trading

Individual investors are acquiring market-moving power as self-directed trading becomes more accessible than in previous years. Platforms support them with better user interfaces, easier access to leverage, sophisticated investing apps, online forums and tools that provide access to real-time information.

These factors have contributed to improving market liquidity and raising visibility for investment products, particularly equity derivatives such as covered call exchange traded funds, options and single-share futures. In 2021, ETF options witnessed a 20.4% rise in trading volumes and equity options increased by 34.9%. This year to date, ETF options increased by 32%, while equity options increased by 19% year over year.

As self-directed investing, in general, becomes democratized and retail investing activity contributes to trading volume, the investment industry and regulatory environments are having to adapt quickly. This is leading major exchanges, including Montréal Exchange (MX), to focus on servicing retail investors and improving liquidity.

Attracting Retail Investors To Canadian Derivatives

In recent years, MX has adapted its approach, addressing the recent surge in interest from the retail community by bringing products to market that align with its financial objectives. MX is constantly evaluating its market model and market-making programs to understand how best to meet the needs of retail investors and promote equity derivatives globally. And we have partnered with some of the world’s largest market-making firms, to improve liquidity and access for market participants, including retail investors.

MX has recently been working on developing its market model in order to make the platform more conducive to global market-makers. One of the more recent changes was to increase the cross threshold to allow market makers to interact with institutional flow. As a result of these changes, we will look to attract more global electronic market makers to our platform and improve the profile of on-screen liquidity and visibility of the order book. Additional changes include potentially developing an auction with a price improvement mechanism that will allow market makers to further interact and improve institutional prices.

MX recognizes that the Canadian dealer community has been instrumental and will continue to be pivotal in developing the listed options space in Canada. That said, we are also mindful that in order to continue to grow, we must bridge the gap between retail and institutional flow in an effort to create a better two-way screen market.

Canada’s regulatory environment is conducive to innovation in product development, making it possible to bring investment vehicles to market faster than other comparable regimes. Some of the sectors that have attracted retail attention of late have been niche sectors specific to Canada, such as cannabis, Ether and crypto. MX has been quick to react to this competitive advantage by listing derivative products in these sectors.

Covered Call ETFs

In the last couple of years, there has been a significant proliferation of covered call ETFs in Canada ranging from the banking, resource, energy and most recently Bitcoin and Ether sectors. Canada punches well above its weight class when it comes to issuing covered call ETFs with approximately USD16 billion across 98 covered call and put writing ETFs. Retail investors have certainly taken notice and gravitated toward these products.

Typically covered call strategies have lower volatility and better risk-adjusted returns, but they are also a relatively complicated investment strategy for novice investors. As literacy levels rise among retail investors, there is a renewed interest in exploring the possibilities available through covered calls in the options market.

Montréal Exchange offers trading for more than 50 ETF options, including several that provide exposure to high-growth, niche sectors. Canada was also the first to come to market with both a Bitcoin and Ether covered call ETF.

Market dynamics are continuously evolving, and the lines between institutional and retail investors are blurring between pure-play products. ETFs provide exposure to specific sectors or broad indices, and a covered call options overlay can help retail investors target the right risk/return profile to meet their financial objectives.

It’s difficult to predict the future, but there is no doubt that the retail investor landscape is having an impact on derivatives trading globally and in Canada. The core principles of investing, such as asset allocations, rebalancing to capture opportunities and disciplined portfolio management are expected to remain unchanged. But we will likely see different cycles of liquidity, perhaps more volatility at times and greater emphasis on ease of investing through apps and self-directed trading platforms.

Author Ron Hochman is head of sales, institutional equity derivatives at TMX Group


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