SEC's approval of Nasdaq-listed options on ETNs: positive trend, but impact won't be immediate

By Emma Trincal

New York, April 22 - The announcement this week that the Nasdaq Stock Market LLC and the Nasdaq OMX PHLX have been granted approval by the Securities and Exchange Commission to list and trade options on exchange-traded notes was seen as a positive for the U.S. structured products market, according to several sources.

The new rule is creating a momentum as the SEC last month approved a similar request from the Chicago Board Options Exchange, sources said.

The Nasdaq Stock Market and the Nasdaq OMX PHLX filed with the SEC their request for a rule change in order to establish strike-price intervals for options on ETNs as well as trading hours for these products last month. On Tuesday, the SEC filed its rulings approving the proposed rule changes on an accelerated basis.

The CBOE had filed its own request on Jan. 27 and received the go-ahead from the SEC on March 12.

Step forward

"I think it's a positive development," said Keith Styrcula, chairman of the Structured Products Association, reacting to the SEC announcement.

"Any opportunity to create enhanced liquidity for structured products is always a positive thing from the perspective of the industry."

New product possible

One possible development, sources said, was the possibility for structurers, now enabled to trade listed options on ETNs, to use the ETNs as the underlying for a new generation of structured notes, the same way they are currently using exchange-traded funds as reference assets for structured products.

"If you can trade options on ETNs, in theory you might see structured products linked to ETNs. If you can buy derivatives on an asset, then you can use it as an underlying," said structured products analyst Suzi Hampson at Future Value Consultants.

"It does make sense to anticipate ETNs as a future reference asset for a new type of structured products," said Styrcula.

"With options on ETNs, you get enhanced leverage, so you can keep costs down. This way you can create structured products around ETNs as we're seeing it happening with the growing market of ETF-linked products," Styrcula added.

What's next, Euronext?

Industry participants said that the next logical step would be to see NYSE Euronext being granted the same permission.

"I'm not aware of any filings with the NYSE, but you can be sure that if one exchange is filing, the next one is going to be on top of it. So NYSE is likely to be next," said Styrcula.

"I expect that options on ETNs will be prevalent on all exchanges," he said.

Practical complications

However, ETNs have pros and cons, experts said, and while being able to trade options on those very liquid instruments is likely to push U.S. structured products issuance to new levels, future developments may not go as fast as anticipated, some structured products market participants noted.

"In practice, there may be some complications," said Hampson. "For instance, unlike an ETF, an ETN involves taking on credit risk. So a structured product linked to an ETN in theory might involve two layers of credit risk."

Michael Johnston, senior analyst and founder of ETF Database, a research firm specializing in ETFs and ETNs, said, "A lot of people are interested in ETNs, but there is a potential downside in that ETNs are essentially debt securities not backed by a pool of assets."

ETNs, however, are becoming increasingly popular, he added.

"There is obviously a lot of interest in ETNs as those instruments offer a lot of positive points. For one, there is no tracking error or almost no tracking error. Given their appeal, a lot of people are not too concerned about credit quality or potential default issues. They've embraced ETNs," Johnston said.

First things first

"I think we're seeing a positive trend, but it's anticipatory," said Styrcula.

"It remains to be seen whether the options on ETNs will be traded in significant sizes in terms of average daily trading volume. On the other hand, I think that commodities and volatility ETNs have an excellent opportunity," said Styrcula.

"Seeking permission is the first step. We still have to build it. It's a $10 billion market," he said.

Calls to Nasdaq requesting comments were not returned.

A SEC spokesman declined to comment beyond the commission's statement as a policy.

A spokeswoman at the NYSE did not respond to a query by press time.

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