SEC approvals for ETN options listings on CBOE, OMX PHLX welcomed by market participants

By Emma Trincal

New York, March 17 - The industry responded positively to the Securities and Exchange Commission's announcement that it approved a proposed rule change from the Chicago Board Options Exchange that will allow the listing and trading of options on exchange-traded notes.

The SEC also gave its go-ahead for the listing and trading of ETN options on the OMX PHLX, formerly known as the Philadelphia Stock Exchange.

The SEC approval is for rule changes needed to establish strike price intervals and trading hours for ETNs, also known as index-linked securities.

Great development

"This is a great development! It will enhance issuance volume of ETNs by increasing liquidity," said Keith Styrcula, chairman of the Structured Products Association.

In support of its proposal filed in January, CBOE stated that it believes the marketplace and investors will be expecting ETN options to trade in a similar manner to options on exchange-traded funds.

The SEC agreed to extend the trading conventions for options on ETFs to options on ETNs, according to its announcements.

A spokesperson at CBOE said that the exchange already has more than 200 listed options on ETFs and that CBOE has not been trading any options on ETNs.

ETF cousins

"We see ETNs as a smaller cousin of ETFs but one that is evolving along the same path," Styrcula said.

"It is only happening now because ETNs are brand new. The ETN market is five years behind the ETF market. Trading options on ETNs listed on the CBOE and the PHLX is a natural and necessary evolution. It clearly shows that ETNs are poised for an explosive growth," he said.

More transparency

Market participants said that the new measure will enhance not only volume but also liquidity and transparency in the ETN market.

"What it will do is hopefully provide some liquidity. It may give ETN investors the transparency that you want to have with normal notes," said Matt Medeiros, president and chief executive officer at the Institute for Wealth Management in Denver.

Medeiros, whose specialty is designing diversified portfolios, said that he welcomed the news even though his focus is on ETFs rather than ETNs.

"It's a plus. Anytime you can offer further liquidity and transparency is a plus," he said.

Enhanced volume

Styrcula said that the expected trading of options on ETNs will enhance the size of this market.

"It's a self-fulfilling prophecy. When the option expires in the money, there's got to be delivery of the ETN and someone has to hedge that. As a result, the options market will create more demand for the ETNs," he said.

"We've started to see options on a large volume of ETFs, and people can get more leverage on these strategies by buying options as long as the bid/ask price is not too wide," Styrcula said.

Liquidity benefits

"Usually for options to trade on an exchange, you have to have sufficient volume of the reference security so the bid/ask spread doesn't get too wide," Styrcula said. "The best options are those that have highly liquid reference assets. It is now possible to do options on ETNs because the ETN market has reached the necessary high volume it needs to have.

"But it works the other way around too: When you start having options, it also creates opportunity for volume."

When and who

Market participants were wondering when the decision would take effect and which products would be most likely to benefit from the listing and trading announcements.

A spokesman at the SEC declined to comment.

A spokeswoman at CBOE said, "CBOE can't comment on timing and product launches."

"I think it will start immediately, since the SEC has approved it. You may see something in a couple of weeks," Styrcula said.

"It's something the exchanges filed probably at the request of some of the issuers. We haven't heard yet of a list of ETNs that can be listed. Not all ETNs will be eligible. It will be based on the volume of the ETNs themselves," Styrcula noted.

"It's going to be a boon for the largest-volume ETNs," he added.

According to Michael Johnston, founder of ETF screener and research firm the ETF Database, some of the most popular ETNs belong to Barclays Bank plc's iPath brand, such as the iPath S&P 500 VIX Short-Term Futures ETN, iPath MSCI India ETN, iPath S&P GSCI Crude Oil Total Return Index ETN and iPath Dow Jones - UBS Commodity Index Total Return ETN.

JPMorgan Chase & Co.'s Alerian MLP index ETN, which tracks the energy master limited partnership index, is also on the top of the list, according to Johnston.

Small fish, beware

Styrcula said that approximately 85% of ETN issuance originates from only 10% of the banks.

"I am not even aware of small players in this market. It's totally controlled by the big ones," a New York sellsider said, citing Barclays, Goldman Sachs, JPMorgan and Deutsche Bank as the leading agents.

Styrcula said that the new measure may not benefit those among the banks that have "tried to build up volume" but that have remained small.

"If only the largest ETN issuers will be able to build options, the others will step out. It provides an opportunity to enhance issuance, yes. But the economics can be unattractive for the ETNs that don't have a lot of volume," said Styrcula.

"The rich will get richer," he said.

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