Observations & Insight

Bits & Pieces
By Jim Kharouf

Next week is one of the biggest weeks of the year for the industry, with FIA Expo in Chicago from October 18th (opening night) to October 20th. John Lothian News will be publishing two pieces in the coming days that we hope will serve as discussion points during the show and beyond.

JLN Associate Editor Spencer Doar has put together a special news report on the growth of options on futures. That segment of the business has grown dramatically in recent years and may continue to be one of the growth segments in the years to come.

John Lothian & Company, Inc. has also branched further into the analysis and thought leadership space with a new report we will also publish next week on the future for FCMs and trading firms in our space. The report is based on an off-the-record conversation with several FCM and proprietary trading firm executives who spoke candidly about everything from regulation, more on regulation and how technology helps and lags in meeting their needs. A big thanks to Itviti, for sponsoring the meeting and report.

Finally, John Lothian News will be at Expo in force. And once again, we will be interviewing professionals for a video compilation on the topic of regulation and its impact six years since the passage of the Dodd-Frank Act. We will also explore the solutions to those regulatory challenges as well as the opportunities it has forged. Our thanks to Cinnober for once again providing us their trade show booth (#314) to act as a studio for our interviews.


Lead Stories

Investors May Be Misjudging U.S. Election Volatility
Inyoung Hwang – WSJ
Stock investors jolted by the volatility spike after the British referendum are overlooking the potential for another shock from the U.S. election, Wall Street analysts say. “Brexit was a big wake-up call. Investor knew that the likelihood of the Leave camp succeeding was greater than zero but they still underestimated the odds and few people hedged ahead of the vote,” said Randy Frederick, director of trading and derivatives at Schwab Center for Financial Research. With the U.S. presidential election, “there’s a little too much complacency. As we approach election, volatility will probably creep up.”

****SD: Bloomberg has Goldman: Economic Uncertainty Has Been Tumbling Ahead of the U.S. Election for more on the subject.

CBOE-Bats tie-up seen as opportunity to reduce trading costs
Rick Baert – Pensions & Investments
CBOE Holdings Inc.’s agreement to acquire Bats Global Markets Inc. could ultimately lead to savings on trading and data costs for institutional investors, sources said. The Sept. 26 deal will bring Lenexa, Kan.-based Bats’ trading technology, including its advanced order matching system, to CBOE’s Chicago Board Options Exchange, “which will be a benefit for investors,” said Valerie Bogard, equity analyst at TABB Group LLC, New York. “Bats has the strongest technology out there, and CBOE’s acquisition of that will lead to growth across the spectrum of their exchanges.”

Buy-Write Funds Don’t Have As Big An Impact As You May Think
Teresa Rivas – Barron’s
Barclays’ Maneesh Deshpande and his team recently took a look at the option trading activity of buy-write funds, and determined that they don’t have as significant an impact as many investors believe. As investors scramble for yield in a low-rate environment, interest in buy-write funds—which follow a covered call’ strategy of buying a stock and selling a call option against it—has increased, with many believing that they have altered S&P 500 options and even the index itself. Yet Deshpande writes that actually money flows into these funds has actually been “stagnant” in recent years. Moreover, their positions aren’t enough to move the needle in the larger option market.

Interest Rate Models and Negative Rates
John Hull and Alan White – FINCAD Blog
In our last blog we reported on the relationship between the level of interest rates and their volatility. However, all of the data underlying the analyses that we reported on in that blog came from 2013 or earlier. Since then we have seen rates decline and, in many jurisdictions, become negative. In this blog we will discuss the models that can be used for calculating the price of European style interest-rate options such as caps and swap options when rates are low or negative.

****SD: Stay away from this if you don’t want to deal with heavy mathematics on a Friday.

Currency investors need razor sharp political instincts
Roger Blitz – Financial Times
This year’s most successful currency investors would have needed some remarkable political insight. They would have had to predict Brexit, the fall of Brazilian president Dilma Rousseff, an attempted Turkish coup and the improbable polling success of Donald Trump. Normally, the foreign exchange market is a slave to the humdrum cycle of jobs data, inflation, business confidence indices and yield curves. But politics — not just any old politics but a highly unpredictable, volatile version — has been the driver of the biggest shifts across currencies in 2016, and in all likelihood will continue to rattle investors into next year.

****SD: I’d argue any investor should have sharp political instincts.

Dangerous, One-Sided, All-In Market
Seeking Alpha
Stocks and other risk assets are seeing a great deal of love from speculators on the futures markets. At the same time, pros are hedging against a stock move downward at record levels according to Skew. Recent newsflow is not especially encouraging, with China seeing a renewed downward slide in exports and various BLS employment details not very strong at all recently. A cautious approach to the markets continues to make sense to me. The recent back-up in interest rates has made bonds less risky than I felt they have been for several months, especially in the 5-year maturity range hated by speculators.


MIAX Options Announces October 24th Launch Date for Complex Order Functionality Following SEC Approval
MIAX Options Exchange today announced that it has received approval from the Securities and Exchange Commission (SEC) to launch its Complex Order functionality and has scheduled an October 24th launch date. Leveraging one of the options industry’s fastest and most reliable technology platforms, Complex Orders will enable MIAX Options Member firms spread price protection and the potential for price improvement while increasing the probability of execution by facilitating up to eight multi-leg orders. This functionality will be available in a limited number of classes following its initial launch. The first symbol to be listed will be iShares Russell 2000 Index Funds (IWM), and additional symbol rollouts will be announced via a future MIAX Options Regulatory Circular.

M&A, Fixed Income Will Be In Focus For Exchanges’ Q3 Reports
Teresa Rivas – Barron’s
Keefe, Bruyette & Woods analyst Kyle Voigt takes a look at exchanges ahead of third-quarter earnings reports, writing that M&A will be a key focus for companies. Voigt writes that with CBOE Holdings’ (CBOE) $3.2 billion deal to buy Bats Global Markets (BATS) in the works, most US exchanges are now actively integrating businesses or tied-up with M&A

Bats Reports Strong September Data, Including 11.7% U.S. Options Market Share Remains #1 in U.S. ETF Trading; #1 Pan-European Stock Market
Bats Global Markets, Inc. today reported September data and highlights, including its second- best month on record for its U.S. options business, with 11.7% market share.

A talk with Bats CEO Chris Concannon
Ari I. Weinberg – Pensions & Investments
Bats Global Markets CEO Chris Concannon has been at the forefront of securities product and trading innovation from the start of his career. During law school, Mr. Concannon served as a legislative analyst at the American Stock Exchange while the first U.S. exchange-traded funds were launched. And ever since, he has held positions integral to driving the modernization of securities trading and exchanges, even as passively managed investing and exchange-traded products helped to transform the modern securities marketplace.

LSE’s Curve trading steadily on the rise
Julie Aelbrecht – Futures & Options World
Curve and Nasdaq NLX are offering a clearing fee waiver until the end of March
The London Stock Exchange’s CurveGlobal futures trading system’s trading volumes and open interest figures have been steadily rising since its inception. The new interest rate exchange’s top day of trading so far was earlier this week on Tuesday October 11, when the on book volume stood at 4,724 and the open interest at 7,618 lots. The highest open interest was recorded the day after, with 8,316 lots.

Acting CEO of Tel Aviv Stock Exchange pulls resignation request
The interim CEO of the Tel Aviv Stock Exchange (TASE) on Thursday withdrew her request to resign at the end of the year, the bourse said.


KCG Holdings Hires Former 3Red Trading Chief Technology Officer
Brian Louis – Bloomberg
Ryan Long joins as trading firm makes senior technology hires; Long also previously worked at Chicago-based Citadel
KCG Holdings Inc. hired the former chief technology officer of 3Red Trading LLC, as it adds technology veterans to its staff. Ryan Long started working at KCG last week, according to company spokeswoman Sophie Sohn. Long is based in KCG’s Chicago office and will be working on the firm’s trading software, she said.

Regulation & Enforcement

Elizabeth Warren to Obama: Fire SEC Chief Mary Jo White
Andrew Ackerman – WSJ
Sen. Elizabeth Warren is calling on President Barack Obama to dismiss Mary Jo White as chairman of the Securities and Exchange Commission, the latest and strongest push by the Massachusetts Democrat to criticize the top markets cop and to influence financial policy-making here. While it is highly unlikely the Obama administration will oblige Ms. Warren in its final months, the request comes as the former Harvard law professor and other progressive Democrats seek to pull their party to the left and influence the selection of the next round of presidential appointees after the November election.

****SD: Wait, Elizabeth Warren is opinionated?

FIA PTG: Speed bumps are fundamentally incompatible with Reg NMS
FIA PTG submitted a comment letter to the Securities and Exchange Commission (SEC) today in response to a proposal from the Chicago Stock Exchange, Inc. (CHX) to introduce a new type of speed bump, the Liquidity Taking Access Delay (LTAD).

British ‘flash crash’ trader loses extradition appeal attempt
Simon Bowers – The Guardian
The British financial trader accused of manipulating the US stock markets on the day of an $800bn (GBP565bn) “flash crash” faces extradition within 28 days after being denied permission to appeal against the order. Navinder Singh Sarao, 37, nicknamed the Hound of Hounslow, must now be sent to America and surrendered to the US authorities.


Artificial Intelligence: Disruption Era Begins
Jitendra Waral, Anurag Rana and Sean Handrahan, Bloomberg Intelligence – TABB Forum
Artificial intelligence software solutions will likely be the top disruptor in technology in the next decade. Software’s ability to self-learn by processing data may spur consumer and enterprise applications. Companies embracing AI may get a competitive edge; ones that don’t run the risk of being disrupted and phased out. AI is nascent, but the pace of innovation and disruptive potential of startups will accelerate as compute costs shrink and machine-learning algorithms advance.

****SD: I’ve been thinking more and more about AI since HBO’s “Westworld” premiered.

Leveraging AI to Minimize Regulatory Enforcement Action Risk
Anna-Lisa Toth, Hatstand – TABB Forum
The regulators are embracing AI to identify and rout out financial crime, leveraging behavioral data analytics to find the needles in the haystack. Financial service firms need to take a page from the regulators’ playbooks and implement similar solutions to proactively stop the illicit activities before they become the next headline and cost the firm millions in fines or reputational damage.

Market grows for ‘regtech’, or AI for regulation; Artificial intelligence and biometrics help banks comply with rules
Martin Arnold – Financial Times
Hedge fund managers beware, someone is watching you. Or rather, something is watching you. A new artificial intelligence system can monitor traders, learn their behaviour patterns and raise the alarm when they do something out of character.

This Startup Is Using A.I. to Speed Up Financial Compliance
Jeremy Kahn – Bloomberg
A U.K. startup that uses artificial intelligence to help banks and other financial firms with anti-money laundering compliance received $8.3 million to fund its expansion in Europe and North America.


2 Option Strategies to Profit From Earnings Volatility
Celeste Taylor – Schaeffer’s Research
With earnings season ramping up, traders might be looking for a way to cash in on this especially volatile time of the year. However, predicting a stock’s post-earnings trajectory can be difficult to do (or else everyone would do it!). For option traders, however, there are strategies that allow you take advantage of big stock moves, regardless of the direction.

Earnings Week of Oct 17 – Oct 21
CBOE Options Hub
With a couple of exceptions (AAL, PYPL) the data below represents twelve quarters of earnings history. As always the data below is based on the last three years of earnings results unless the ticker is in italics. The columns show the biggest rally, biggest drop, average move, and what the stock did last quarter in reaction to earnings. Finally, double check the earnings dates as not all were confirmed.


Size Matters: How Leverage Works in the Financial Markets
Retail Crowd
In the world of finance, leverage is a powerful tool traders use to maximize their returns. In essence, leverage is the strategy of using borrowed money to increase return on investment. The borrowed money is provided to the investor by the broker that is handling the account.

The business of hedging
Catherine Snowdon – BBC
We’ve all heard the phrase hedging your bets – but do you know what it actually means? “Hedge” has been used as a verb meaning to “avoid commitment” since at least the 16th century; it’s used in Shakespeare’s Merry Wives of Windsor, for example. It started being used in relation to financial transactions in the early 17th century. Technically it is a way of managing a financial price risk. But let’s take it back to basics.

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