By Telis Demos
A surge on Wall Street stock-trading desks is being driven by
manic investor moves in derivatives, as fund managers scramble to
protect their gains from future volatility.
Following a leap in stock market gyrations so far this year, the
biggest U.S. banks generated more revenue from stock trading than
in any first quarter since the financial crisis, according to a
Wall Street Journal analysis of bank regulatory filings.
It's been a long time coming. The business of trading is still
far from its precrisis peak, when fewer trades were done
electronically and overall fees charged by banks were higher. Now,
more trades are done automatically, leaving razor-thin margins for
traders. And while activity has had ups and downs, it's been muted
in recent years due to low interest rates and sagging
volatility.
This past quarter, however, volatility returned and derivatives
such as stock-index futures and options picked up along with
activity in exchange-traded funds, which also reside in banks'
stock-trading, or equities, departments.
Overall, U.S. options trading enjoyed its busiest quarter in
history, by one measure, according to research from consulting firm
Tabb Group and data provider Hanweck. Nearly 1.4 billion options
contracts were cleared in the first quarter, up 33% from a year
ago, the firms said.
"Some days, it was like nothing I've ever seen before," said
Peter Maragos, chief executive of Dash Financial Technologies, an
options and equities electronic-trading technology provider.
Only a small portion of the revenue upswing came from the buying
and selling of actual shares in companies, according to bank
trading executives. Instead, the biggest gains grew out of clients
such as mutual funds, hedge funds and pension portfolios trading
stock derivatives, with some investors aiming to hedge their
positions and others speculating on more big swings.
If the volatility remains elevated and clients stay active,
moving their money to take advantage of new opportunities, "you
could see this revenue level for the next three quarters" at banks,
predicts Guy Moszkowski, analyst at Autonomous Research.
But recent trends suggest that many fund managers won't
necessarily be looking to put more money to work in the market if
prices drop. In a volatile market, banks also face elevated risks
that they could be caught on the wrong side of a trade.
"Everyone in equities is now thinking about preparing and taking
on more insurance," said Brad Bailey, research director at Celent,
which advises financial firms on technology.
Derivatives contracts, which can tie to any instrument from
stock indexes to interest rates, have a long and colorful history
on Wall Street, generating lucrative paydays but also painful
losses due in part to the ease with which they can be used with
borrowed money.
The biggest banks, in particular, have seen ups and downs in
equities, including more than $1 billion in losses last year tied
to the former chairman of South African retailer Steinhoff
International.
In the first quarter, equities trading revenue at the five
biggest Wall Street banks -- Morgan Stanley, Goldman Sachs Group
Inc., JPMorgan Chase & Co., Bank of America Corp. and Citigroup
Inc. -- was $9.5 billion, the largest haul for those firms since at
least 2009, according to the Journal analysis.
The 32% jump from last year's first quarter was the biggest
since 2011, and far greater than analysts anticipated.
Switzerland's UBS Group AG, which is also a large U.S. equities
trading firm, reported Monday a nearly 25% jump in first-quarter
equities trading revenue, as measured in dollars, from a year
earlier.
Driving the jump was equity derivatives; revenue at some banks
in that department rose by more than 50%, people familiar with the
matter said. Meanwhile, actual stock trading, known as "cash
trading" in Wall Street parlance, was generally up only a small
amount from a year ago, the people said.
The results helped make up for a slight dip in performance among
those banks' larger fixed-income, commodities and currencies
desks.
Morgan Stanley Chief Financial Officer Jonathan Pruzan said
equity-derivatives trading was "the highlight" of the quarter, in
which the bank's equities revenue rose 27%.
Banks' equity-derivatives units span a mix of complex products
that are designed to pay off when stock or fund prices move,
according to Coalition, a research firm tracking banks.
The business had been hurt by low volatility over the past two
years. Revenue in equity derivatives fell by more than 25% across
the 12 largest global banks from 2015 to 2017, Coalition noted.
Then, stock-market volatility returned, with the Cboe Volatility
Index, or VIX, surging well above 20 during the quarter, up from
single-digits much of last year. In fact, one of the hottest areas
in derivatives tied to stocks are bets on volatility.
Big banks' trading desks benefited in particular as large
investment firms -- their key clients, as opposed to retail
investors or high-speed trading firms -- increasingly sought
derivatives to hedge against sharp market moves, according to
senior equities executives at large banks.
Meanwhile, the same volatility kept many stock buyers away from
the market. More than $15 billion flowed out of stock-based mutual
funds on a net basis during the first two months of the year, about
four times 2017's level, according to the Investment Company
Institute.
--Liz Hoffman contributed to this article.
(END) Dow Jones Newswires
April 25, 2018 11:48 ET (15:48 GMT)
Copyright (c) 2018 Dow Jones & Company, Inc.
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