New Sector Futures Give Traders More Hedging Power

Derived Blocked trades are also gaining traction with the institution’s customers.  

“We have had a number of clients checking prices and getting familiar with the tool so there is growing appetite for its use,” said Steve Christian, managing director of execution sales at Citi. “The facility allows clients to access underlying liquidity at any point during the cash session. That is an improvement from the previous, more captive basis trade at index close (BTIC) which was settled at the end of day.”

The last (or Phase 6) of the Uncleared Margin Rules (UMR) regulation raising buy-side firms’ margin costs came into play on September 1, putting 1,100 firms into scope. As firms work to adapt to new initial margin requirements, managing capital efficiency has become increasingly crucial.

The fledgling sectors help in this regard, especially when it comes to trading futures versus ETFs, according to Joe Paccione, head of Americas Futures and Options Sales and Execution at J.P. Morgan.

“With UMR continuing to phase in, capital efficiency is on everyone’s mind,” he said. “As more and more of the OTC products move to listed, it creates additional resources to balance exposure and enhance margin efficiencies.”

Amid this shake up, the ability to execute block trades has become a “turning point” he said.

“The derived blocks create additional access to liquidity throughout the day, allowing traders an alternative method of getting their hedge off, potentially putting that risk into futures,” he said.

“I think that feature brings it on par with other products. Then you add in capital efficiency and the UMR rollout, I can see more and more interest moving to futures.”

Meanwhile, Crudele expects the increasingly popular oil and gas and semiconductor and biotech sectors to gain the most traction as traders begin using the new contracts. 

“The oil and energy sectors are the most popular in the S&P 500 this year so there is a lot of liquidity,” he said. 

“Semiconductors and biotechs are also high-flying sectors right now,” Crudele added. “With semis, you have a massive amount of volatility coming as you never know what will happen with geopolitical risk, and semis are a key part of our technology world. When you look at Nvidia and AMD, for example, a ton of retail and professional investors are trading these stocks every day.” 

The biotech industry also remains susceptible to headline-driven volatility.

“We are in a world where a lot of headline risk is going to come from the biotech side of things because of fear of new COVID-19 variants or a new pandemic and now the Monkeypox outbreak,” added Crudele.

Paccione at J.P.  Morgan says the firm’s clients have more options as attention moves from one sector to another.

“It’s not that one is more popular than the other or one is more desirable than another,” he says. “Now that you have this option within the futures construct, it will provide an additional alternative for customers, allowing them to use futures as opposed to just the OTC markets or ETFs.”

Crudele also sees traders using block trades to more precisely manage risk or express their view on a particular sector or index performance. 

 “The exciting part of the E-mini S&P is that it’s the most widely traded index in the world. From that perspective, we can now trade the strongest versus the weakest sectors and create strategies beyond trading the single index,” he mused. 

Before the six new sectors’ launch, “we mostly traded S&P and ESG indices, but these new sectors are really hitting where the volatility is in the current marketplace,” he added.

“If you have a big stock portfolio and you look at the S&P and say, ‘I want to short it but have a heavy weighting in oil and semiconductors,’ you can offset that by going short on the S&P and simultaneously long on oil and semiconductors. In this way, you can more accurately express your view.”

Citi’s Corin expects demand for the E-mini sector futures to grow sharply in the future. 

“There are many investors who don’t have the ability to trade cash instruments so this could open up a window for certain market participants to trade sectors they have not had access to historically, generating additional liquidity in the process.”