Q3 2023 has seen a new record in equity index options trading at CME Group as volumes have exceeded 1.6 million contracts per day.

This growth mirrors the explosion in single stock and ETF index options where those volumes doubled between 2019 and 2022. The decades-long driver of the trend appears to be a growing sophistication among traders as new tools for information and analytics have become easily available. But the volume growth over the last few years has been jaw dropping.

I recently sat down with Tim McCourt, Global Head of Financial & OTC Products at CME Group, to discuss the trend. McCourt believes it's comprised of several things, saying “It's a combination of risk management in this market… and they're a great low-cost, capital-efficient” way to express your trading thesis or hedging strategy. He also pointed out that the record-setting third quarter volume came in a “slightly lower market volatility environment… which is pretty impressive.”

Another interesting component in the options trend is the gravitation to much shorter-dated options compared to past years. Tim called it the “next chapter of a multi-year story” and noted that “just a few years ago we were talking about how wild it was to see that most of the activity was 10 days and under. And now we're seeing tremendous activity in five days and under, or even same day.”

It’s important to remember that one of the key elements of options pricing is time until expiration. The more time until expiration in the option, the more expensive it will be. If a trader needs to hedge risk or express a directional opinion around a binary event that occurs on a Tuesday, next Monday options may seem prohibitively expensive, McCourt explained. This mindset helps explain the bump-up in trading volumes that surround big data releases like the CPI report or major central bank decisions. Short-dated options allow traders to narrow their focus to a specific risk in a specific time frame.

Something that many analysts have disagreed on is the question of whether these huge options positions may elevate broad market risk. An example would be what's called a gamma squeeze. An easy way to explain this would be a situation where there were large short positions in a call that was at a strike price above the market. If the underlying market rallies through that strike price, the sellers of that call have market risks that grow exponentially along with the price. And their need to buy back the call or the underlying asset pushes the market further and faster in the same direction. McCourt seems to believe that, although the risk is real, the users of these products have become more sophisticated and more in tune with defining their own risk. He notes that “the dispersion of strikes and types of strategies used has increased” and that it must be “largely risk management” we’re seeing, making it less likely for an accelerated, market-moving push to exit positions.

Finally, we discussed the growing global uncertainty we’re experiencing with elevated geopolitical tensions and increasing conflict on top of historic levels of inflation and interest rate hikes. At any moment, headline risk can do significant damage to a trader's portfolio. According to McCourt, “As we've said a lot here at CME Group, risk management is the new alpha. if you're not managing risk more precisely, more prudently, more assertively, the real question I have for market participants is why not? What are you waiting for?”