The outlook for the options industry is a lot less sunny than the skies in Miami Beach, if you listen to the Tabb Group’s Andy Nybo. The industry faces major challenges right now, including a lessening of liquidity, widening bid-ask spreads, and market fragmentation, Nybo told the audience Thursday morning at the Options Industry Conference in Miami Beach.

A recent Tabb study found that these are particular problems for institutional traders, he said.

Overall spreads have widened, but the tiering of liquidity has created a bifurcated market in which 75 percent of all options traded are in the top 100 stock names, Nybo said. Those names are actually showing tighter spreads, while in the less-traded names spreads have been as wide as 41 cents per contract.

And those less active names are heavily traded by retail investors, who make up slightly less than half of all options trading. In addition, the Labor Dept. is looking at the use of futures and options in retirement accounts, which could lead to further targeting of the financial industry to raise revenues, he said, adding that regulators have a “mentality that it is all Wall Street’s fault.”

In addition to heavy trading, retail traders are also engaging in some more interesting strategies, such as spread trading and three-legged strategies, which are growing fast.

Weeklys have also become extraordinarily popular – but the trading in weeklys is even more concentrated in the top actively traded names, in fact it is concentrated in the 10 most popular, Nybo said.

All this concentration is a challenge for brokers, exchanges and clearing firms.

Technology has been a huge driver of change in the industry, enabling faster markets and more markets, with peak messaging this year at 10 million per second, an increase from last year.

Nybo said the industry must keep a watch on Washington, especially heading towards an election, and noted how great the impact of certain rules and proposals can be on the industry – including the proposal to make hedging with options a taxable event.

OTC action is also contributing to a loss of liquidity, he added.

Consolidation is hurting market makers; even some of the biggest market makers such as UBS and Credit Suisse have exited the business, pushed out in part by Basel III implementation, he said. Smaller market makers are struggling.

Nybo emphasized that regulatory policies – both US and international – are “the key obstacles to growth” within the options industry, and that the upcoming presidential elections may bring about unwelcome changes.

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