Kurv Your Enthusiasm - Episode 06
Volatility Part III: Bill O’Keefe from Cboe on the Evolution of Options Trading
In this episode, Kurv Investment's Howard Chan and Cboe Global Markets' Bill O'Keefe discuss the evolution of options trading, focusing on the role of Cboe in the market and the changing dynamics of volatility. They explore the increasing sophistication of market participants, the rise of FLEX options, and how these developments have influenced trading strategies and market behavior. The conversation highlights the importance of understanding volatility as a key component in portfolio management and the resources available for further education on these topics.
Chapters
00:00 Introduction to Volatility Series
01:38 Understanding CBOE and Its Role in the Market
06:45 Bill O'Keefe's Journey in Options Trading
10:48 The Evolution of Volatility and Options Usage
17:20 The Dynamics of Trading on the CBOE Floor
24:28 Understanding Types of Options
27:01 Market Dynamics and Trading Volumes
37:00 The Future of Options Trading
Bill O'Keefe (00:00)
that's the biggest change I've seen is just a
Some people stepping back and some people getting into it too. people want to take advantage of the high vol.
Howard Chan (00:13)
hello, everyone. we continue our series on volatility. This is part three of our volatility series. And today we're doing something a little bit different on our podcast. We have Bill O'Keefe from Cboe and he is our inaugural guest on Kurv Your Enthusiasm.
We're very excited for him to join us. And as an introduction, Bill O'Keefe is the Director of Derivative Sales at Cboe Global Markets. He works with insurance companies, ETF issuers, with option-based strategies to understand how to implement their strategies
Prior to working at Cboe, Bill ran a FLEX-only execution desk at Exchange of Financial Access, and he was a member on the floor of the Cboe options exchange for more than 17 years. So welcome, Bill. Thank you for joining us on Kurv Your Enthusiasm.
Bill O'Keefe (01:13)
Well, thank you for having me. Appreciate
Howard Chan (01:16)
So we're very excited to have Bill here because in our series on volatility has been largely theoretical and how we trade. But it's always good to have somebody who has a real time practical experience, especially being able to see the entire options market and somebody who's very familiar with the entire landscape. So Bill, maybe for those who are not familiar with Cboe, could you maybe give them an introduction of.
what Cboe is and what role does it play in the market.
Bill O'Keefe (01:46)
Sure. Cboe was formed in 1973 as an offshoot of the Chicago Board of Trade. And what it was, was the first exchange trade essentially cleared place to do options business that prior to that, it was all done over the counter. And Cboe launched in, I think the spring of 1973, they launched with 16 equity names and they only had calls only. And then more products came on throughout the next couple of years. And I think in 1976 or seven, then they introduced puts.
So was kind of interesting that it was a call only exchange for quite a while. And then by 1976, there was three other exchanges that joined. There was the Picos, the Amex and the Philly exchange. They were doing their own listing. So what would happen, there would be an allocation of names. Let's say a new name like, IBM, for example, let's say they're new on the board and it was an allocation, what exchange gets it? And then it would just be like a wheel. And then, know, if you've got IBM, lucky you, you have IBM and
It was just kind of rotating things. everybody had their proprietary products for it, if you will. And that lasted until about 1999 when the ICE exchange came out as an all electronic exchange. And that was to the demise of a lot of traders like myself that was independent, trading their own account. And then what happened when you had these multi exchanges come, the price discovery was the markets got a lot tighter. You're competing against other exchange, other bigger market makers are drawing the exchange. So the independent little guys like me.
were kind of, you basically forced out unless you work for a large firm. But getting back, that Cboe also was the pioneer in a lot of this stuff, being the first to market 1973 as an exchange. They're also were the first to put together indices such as the S&P 500. Prior to the S&P 500, one of the biggest ones was the OEX, which was the Options Exchange Index, which was, you know, 100 names versus the 500. The 500 has been the industry standards ever since. We also have products at the Russell 2000 index.
the DJX, you know, and those kinds of things too. So, yeah, so right as we speak to every sitter today, there's 19 other, there's a total of 18 other exchanges for a total of 19 right now. So the exchanges are getting very, very competitive and they compete by different price payment methods. When I was a trader, it was called a payment for order flow. So you would put the, you know, an issuer or a bank would say, okay, if you want my business, what are you going to pay me?
So if it traded in our exchange, we had to pay a fee to that. So it just really disenfranchised the little guy. to today, it's much more, I got to hate to admit this, it's much more efficient. It's bigger, it's broader. It could handle the broad width, the broadband of all the options that are being quoted. There's probably 4,000, at least 4,000 names that are publicly traded, that are traded through all these other options exchanges. Everybody multilist everything, right?
So IBM is listed on all the exchanges. The only exception are if you have a proprietary product, like say S&P 500, for example, that is only tradable at Cboe. So yeah, so here we are today. ⁓ We're still the largest exchange by volume and percentages. And ⁓ we're the leader, too, in many innovations, which we'll get into later as we discuss FLEX Options. But that's all I have, basically, on why it's there.
Howard Chan (05:01)
Okay, well, I'm really interested actually, how did you personally get into working for Cboe? Because clearly you have had a lot of experience with options. How did the, evolution of the market lead you to Cboe? ⁓
Bill O'Keefe (05:14)
Evolution.
That's a great question. what was good about it, was, you know, I started as a trader in July of 1987. So three months in or four months into it, I saw the real crash. So that's an invaluable experience. And back then people were trading a flat volatility. They were looking at skew. Skew didn't start until sometime after the crash.
So you learned a lot on the thing. So as a market maker for several years as an independent, you know, went through a lot of different phases. Then basically, when, back in 99, when there's more exchanges come to the marketplace and it got a little tighter, more competition, by about 2004, a lot of the independent market makers had left the business. You know, unless they're part of a big firm, let's say like Susquehanna or Jane Street or the big banks that, you know, they could have the financial engineers, the quants.
which are the cowboys as we were back in the day. They're the ones that are driving the innovation now and making it as robust and quick as it is today. back in 2004, I kind of left the business, but I still had a love for options trading and the exchange. So I worked at a small Chicago based hedge fund that was option based. And then around 2010, ⁓ was asked by a, well, I'm MF Global, I'll be transparent.
went under back in 2011, they wanted me to start an options training desk there, even though they're more of an agency group. So going back and forth, so long story short, an opportunity came up at MF Global where they needed to revamp the floor execution team. So they asked me to do it. I was in charge of business development. What's my job? What am I going to do? What is my focus? And I said, the number one thing I think is a great opportunity is the over-the-counter markets, right?
and it's being in way of this FLEX option stuff, which again, which I get into a little bit later, but I just to wrap up my story. And I focus on that as a focus and it was a slow build. It was really underutilized at the time. There wasn't a lot of participants, but that kept me in the game. So then I got on the sales side. I built an execution desk only that only catered to FLEX options. So I became a really good expert on FLEX options, how they work, what they are, where the client bases are, where everybody is at. So
That was my story. then I did that from 2010 to about 2019 is when I joined Cboe. I'll wrap up. know I'm kind of going on, but you asked the question, so I'll give it to you. So I was like the de facto expert on FLEX. And anytime someone from Cboe had a question about FLEX, they called me, hey, Bill, what do you think about this? Will this work, et cetera? Then in 2018, the first ETF issuer launched a Buffer Protect based ETF using FLEX options.
Howard Chan (07:42)
No, keep going, keep going.
Bill O'Keefe (08:02)
And that kind of put it on, that kind of was a big boost that the FLEX markets needed. It was growing slowly from 2010 to about that time. But in 2018, that was the one that really put the mark on it. Then other issuers tried to do the same thing. And then they realized, hey, what is this FLEX? They learned about it. And it's phenomenal utility that they use in it. I was doing as a broker, all these things were predicated at the end of the day. So I was a one man operation at my shop.
And so a lot of these trades came right at the end of the day. was very stressful. I didn't have any backup. And then I realized, like, you know what? I got to do something different. And I talked to the CEO at Cboe at the time. Hey, listen, this is about to explode. You can see the momentum. we haven't seen anything yet. He goes, you know what? I agree with you. And I said, I'd to join and run this effort here at Cboe, which they then bought me on. And it's been a...
uphill from here. mean, it's this market has exploded as I'll show you some evidence on some of these charts I can talk about a little bit later.
Howard Chan (09:03)
Yeah, and I will definitely do a deep dive on FLEX, but I wanted to go back a little bit is, in this series, we're trying to introduce the concept of volatility, both as a diversifier in the portfolio and people using it in different ways. Have you noticed since you started in the business that has the users of options and how people think about volatility changed? ⁓ Because I think for many,
Bill O'Keefe (09:12)
Mm-hmm.
to me.
Howard Chan (09:32)
We have more more advisors than self-directed investors who are interested in options, but it always seems a little bit of, there's a sort of a lots of Greeks and lots of numbers. And that generally had been in the realm of a lot of institutional investors. How have you seen the user base change over the years?
Bill O'Keefe (09:36)
Bye.
Mm
Well, usually it's interesting, that's a great question, because obviously back in the day it was simple. was calls and puts. You buy and you sell them, you do a little spread, then you do a little bit of arbitrage, you try to play that game. But then I call it clean hedging, mean, like say an insurance company does an annuity, they take X amount of notional dollars in and they have to put that to work. And they buy it on that example, buy an SPX call spread that's customized.
But that's an exact use of it. And I think if you've seen a precise use of options instead of the so-called speculative nature of them or the leveraging nature, which is still, I mean, that's probably still the biggest part of the business. However, I've seen a lot more smart uses of this, ⁓ you know, whether it's from the institutional side, the hedge fund side, insurance side, and all these ETF issuers. So I think it's definitely has changed quite a bit and used as a utility to the fullest extent right now. It's really something else.
Howard Chan (10:45)
you mentioned that, which is kind of interesting to me, that volatility used to be flat. And now we've had, since the financial crisis, this sort of spikes in volatility quite often, you know, people keep talking about, you know, that two, three, four standard deviation event that never happens, happens much more frequently than most people expect. So how has the
Bill O'Keefe (10:51)
Yeah.
Dominique Tersin (10:51)
Hmm.
Bill O'Keefe (10:58)
Right.
All right.
Howard Chan (11:08)
nature of volatility also have changed. Why was it flat versus now? Is it just more...
Bill O'Keefe (11:14)
You know, it's
just the maturity of the marketplace back in the prior to 87. I'm sure that you don't forget that at the index level, the Dow Jones, what is it was 800 or 11 or 12. I don't have in front of me, but the moves weren't they were big moves in percent terms, like a 2 % move, but it was still nothing. Right. It wasn't detrimental to a P/L necessarily. So I think back then, you people were just trading, you know, as a trader back in the early days.
you would get a run of theoreticals from your clearinghouse or your firm that you were working with, and you just use them all day. So you would just kind of, it was a flat volatility across the board, generally speaking, right? And then you take out the dividends and all this other stuff. So, but after the crash, like you said, it changed dramatically and you've seen a lot more of those kind of black swan events. interesting enough, even during, say for example, COVID crisis, right? It was really bad.
for a while, but it mean reverted so quick. But I think the regime we are now, this is what, about three weeks into this now, this new, term. Yeah, the Liberation day, yeah, right, since what is that? Yeah. So, you you've seen a lot and what happens is, yeah, everyone loves volatility. The traders love it, right? In fact, we had the largest day contract wise in the SPX on that Friday of 6 million contracts, which is massive. Prior to that, old record was 4.8 million. So,
Howard Chan (12:16)
Liberation day.
Dominique Tersin (12:18)
Yeah.
Bill O'Keefe (12:36)
It's a tremendous amount of notional. It's like $420 million of notional on that day, if you look at it that way. But then that was great. then you sort of had that mean reversion with it uptick. But then it comes back again. It's all tweet generated or X generated and this and that. So it's going on. And what you're seeing now is you're seeing a little bit of pullback. It's human nature. So a lot of people that are playing in it aggressively every day, the people that are trading the zero-days-to-expiration options.
they might take a step back, like, wait, I'm a little afraid now. Is this going to be up 800 or down 800 in the Dow? And am I on the right side of the market? If I'm wrong, I could be wrong by a lot. I sell a credit spread here and I could get, know, so there's a lot of emotion, right? And then I think people like, love volatility, but they like it after a calm storm and then they get, then they get back into it, right? It just, it's, it's a rebuild. It's a re a fresh start. That's how I see it. And I think that's, that's the biggest change I've seen is just a
Some people stepping back and some people getting into it too. people want to take advantage of the high vol.
You know, if you look at, if you're buying a buffer protect, right? You're buying a call or put spread, that's going to cost more now, of volatility. How do you finance that? You sell a call, that's increased volatility as well. So you're to get this very generous cap after a regime like we had. So there's some good consequences that can come out of volatility uncertainty.
Dominique Tersin (14:01)
And from the volatility, I guess a way to measure it is a VIX indices. When was it created? OK.
Bill O'Keefe (14:08)
Yes.
Well, the index was created in
1993, It was done by an academic team and then Cboe partnered and we did a index methodology on it. And I think it started trading in 2004. It's funny, I was still on the floor in 04 and it was, the VIX was in a very small pit. There was like three people standing there, two brokers in and one market maker. All summer long, I'm looking at it, I go, they're not doing it. This thing's dead in the water. And then here we are, right? And I was like,
Dominique Tersin (14:14)
Yeah.
Yeah.
Bill O'Keefe (14:36)
That's
thing you come up with this way we think is a very good idea of a product, whether it's ⁓ conceptualized as a academic index that turns into an asset class. And that's a great example of it. And another thing I want to talk about Cboe, you we innovate a lot. We have variance futures now listed. We have, you can do Asian and Cliquet style options, which that's kind of like, you know, that's more than insurance company stuff. We have, corporate bond index futures. So
We're doing all sorts of things. And I failed to mention two of that. We also have an ETF listings, right? So we can list the products and capital markets on our exchange as well. So ⁓ I wanted to mention that as going back to question number one, but this is about volatility now.
Howard Chan (15:22)
Yeah, no, we definitely appreciate that because we also have our own ETFs and we work quite closely and it's always been a great partnership with Cboe. I'm also just curious, you clearly, when you were at MF Global or where else, you were a user of options and then when you're at an exchange, you're facilitating the trading of options. How's the difference between the two sides?
Bill O'Keefe (15:50)
Yeah, as a user of options every day is your job as a trader, you live and die by it. And then at the hedge fund, you were working with options every day. But then once you focus on the sell side, I had to be there to accommodate. It was less about me trading. In fact, I rarely trade options anymore because I'm focused on helping our client base at Cboe get them to be trading options more. It's more important that they trade options than me.
That's going to help our exchange out and keep what we do is ⁓ the right thing to do and be conscious of the regulatory bodies that be and do everything correctly over here. We take all that stuff seriously.
Dominique Tersin (16:34)
I was just wondering Was it like, you know the movie Trading Places? Was it like this at the Cboe?
Bill O'Keefe (16:41)
You know, it was because,
a, there was a, all the, all the firms, the bank firms, Morgan Stanley's, Merrill Lynch, they all had a presence on the floor and they would get an order over the phone or a little tape, ticker tape with an order ticket and they bring it to the broker and the broker had to execute the order. So it's competitive. So, you know, they'd ask for a market, you give a two-sided market.
And then everyone would like yelling, you know, buy it, buy it, buy it. Yeah, it was like that. It was interesting because this comes up a lot because when we show people on the floor, I mean, it was easier back then. We probably in the earlier days, you only had three or four or five individual stocks that we had to cover in my little pit. They several, about 70 little pits across the floor. They averaged maybe four or five stocks. And then as we got into the nineties, you know, with the dot com and everyone, there was more listings and more products came to market. It got a little more difficult, but it wasn't. So you became an expert in your four or five stocks and you really understood it.
Dominique Tersin (17:09)
Thank
Bill O'Keefe (17:35)
You knew the order flow because like I said earlier, Cboe, if you had a name on Cboe like ITT for example, that's the only place you could trade. So you got intimate with it. You knew the order flow. You knew when things were coming and all that stuff. But it was chaotic at times when it gets busy. Everyone's coming at the same time. There's a takeover coming out and you seven brokers yelling and screaming. But it's amazing. You have a sixth sense that kind of kicks in how you could just kind of hear everything.
And just you don't you hardly missed anything. Obviously, you're going to miss some things, but it was really it was as chaotic as it looked. It was very efficient.
Dominique Tersin (18:01)
Yeah.
Howard Chan (18:11)
Yeah, I just want to say that if anybody had the privilege to walk on the floor of Cboe, of all the exchanges, is the one that has the, I would say the most traffic, the most excitement activities on any trade floor. I'm actually curious about that because, you know, if you go to some other exchanges, the floors are mainly pretty quiet because they've converted to electronic trading. There's maybe just a few people walking around.
But there is a lot of activity on the floor of Cboe. Like, what is the mechanism of the seat there?
Bill O'Keefe (18:42)
you ⁓
Yeah, on the training floor, technically
right now, the Cboe is the only place that has an active live floor. And that is the SPX pit. And although even though more than about 60% or more of the activity in SPX is electronic, if you take into account the zero-days-to-expiration, which is probably 40% of all the volume on a daily basis, and then the weeklies, the Thursday, Friday, then the next Monday, Tuesday, and Wednesday.
the shorter days durations where the markets are tighter and there's a lot of interest in it. Those are the, I call them the point and click numbers, right? That feeds off electronic. But when you got an index level like 54, 5500, like you do, mean, too a lot is a $1.1 million of notional coverage, right? So you talk about a 10,000 lot spread that has millions, hundreds of millions of dollars of notional. Do you want to, you do an eight legged spread that's complicated, nine months out, a year and a half out. Do you want to press go and hope? Uh-uh.
Because the markets are wide to protect themselves for obvious reasons, The size of notional. But the whole point of having this robust marketplace is, you you might be here, but by the time you get, you you negotiate, it comes down to here because you've got all the big guys playing in the space, the Janes, the old missions, et cetera. And, you know, so, you know, you do need it for the complicated, you know, multi-leg trades where you do need that price discovery.
You know, nothing I see quite a bit is speaking of OTC trades when a large OTC trade goes down, but we don't see it. It's opaque. Within, you know, say 20 minutes or so, all of a sudden they're taking their Vega risk and they're doing something in the SPX bit because nine times out of 10, most of the OTC options businesses based on the &P 500, right? So you do see the residual flow of that unwind, if you will, or the hedging of the OTC traders.
Howard Chan (20:40)
Interesting. That's one characteristic that is very unique to Cboe, I have to say. ⁓
Bill O'Keefe (20:47)
Right. No, it's
another thing that I want to bring out too, since you talk about SPX, is there's a box option strategy I think we've talked about in the past, where it's actually, it's a rate driven, right? It's driven based on the market conditions. So you can extrapolate an interest rate outside of, know, Fed funds, outside of treasury, based on the option piece. And people are using that as a borrowing and lending facility. So it's an amazing thing. So you could be quoting this thing two years out.
Well, what is this rate you're to plug in? You're going to plug in what the market is dictating, not what SOFR is saying or not. You know what saying? So it's kind of intriguing. I think something to look into. It's a little esoteric, but it's something to bring up.
Dominique Tersin (21:31)
Do people... it's a very special question, but do people do that on the American option or just European? European.
Bill O'Keefe (21:42)
No, no, no. Yeah, because yeah, because America, obviously,
you have the assignment and early exercise risk. So this is obviously all European style. But I'm glad you brought that up. Yeah, because that's that's that's another big driver of FLEX, because right now, if you want to trade a standard equity name, you it's all American. That's way it is standardized. However, you can change the you know,
Dominique Tersin (21:52)
FLEX I guess.
Bill O'Keefe (22:08)
conventions of it by using a FLEX, having European style, a ⁓ customized strike, and go out to 15 years. Well, good luck finding liquidity out to 15 years, but that's what the rules say we can do.
Howard Chan (22:21)
I think it'd be interesting for our listeners to talk about the different types of options that are being traded at Cboe.
Obviously there's listed and then there's a special form of options that maybe are not as well known to the advisory market as the FLEX option. I don't know if there are other actually other types, but maybe you can describe these different forms of options that's being traded through Cboe.
Bill O'Keefe (22:46)
Yeah, I mean, obviously, like you said, the the standard American style equity options have been around since day one. The cash settled index options have been around for quite some time. And these are standardized. The strikes are in increments, you know, ⁓ depending on the price of the stock. But, you know, for the larger ones like the SPX, it's five dollar increments, right? Over several months of ⁓ exposure, you know. But then we have what's called the FLEX options, which are fully customizable.
You cannot see a quote on them because it's all RFQ, which stands for Request for Quote, pretty much like the OTC world. And what FLEX Options allows the client to do is to build out their own cadence of, well, I need a special strike. I need a special amount of time for expiration. I might have a concentration issue. I have a hold on a stack and I need 173 days exactly to cover my hedge. And so FLEX can give you that. We talked about a little bit earlier.
Good.
Howard Chan (23:44)
Yeah. So
you were one of the pioneers of FLEX options. So like how did this market originally came to be? Is it just the customization that people wanted that they were not able to get from listed options or how did this market form?
Bill O'Keefe (23:57)
Yeah.
Well, we were we looked at what's going on in the OTC market back in 93 was when FLEX came to reality at Cboe. I was on the floor back then, obviously. And they just looked at this as an opportunity like, hey, you know what? I mean, you know, people in the OTC world, have this agreements, this bilateral credit risk against one entity and all that. We figure, well, if this standardized, ⁓ you know, listed options world works well, exchange trade is essentially clear. Why can't we bring
some of this OTC look-alike business here. So that was the impetus for Cboe to go down that route. And again, it was very underutilized until maybe 15 years, 20 years later.
Howard Chan (24:41)
So I mean, I always have this question, why would anybody still want to use an American option?
Bill O'Keefe (24:47)
Yeah,
right. Exactly. mean, just too many things can go wrong.
this just shows, know like right now, it goes from 2015, the average daily volume in pink is cumulative of the three. It's kind of confusing. So back then it was called seven million contracts at ADV for all the exchanges. And you go all the way up to 2024, about 80% of the way up.
You can see it peaked out about $50 million per day. then lower you see the dark Navy, that's the FLEX option market, right? Now it looks small relatively speaking, and it is relatively speaking. And then in the aqua, that's your ETF ADV. And of course the pink is the individual equities. That's still the biggest, right? mean, there's, you know, those kinds of slides. But one thing I want to point out on this, if you look at the annual growth on the far right,
The fourth one down in green, the one year FLEX is under FLEX is went up 122% year over year. That's just amazing. It's just, so the whole marketplace, not just about FLEX, the whole marketplace, all the options exchanges that are there, the advent of the Webull and the tastytrades and all the online retail brokers operations that are doing a great job educating their people.
And a lot of them are trading zero data exploration, oddly enough. You would think a cash settled index would not be the domain of a retail trader, but they're driving it a lot. And what I see what they're doing just as observation is if they're taking just, I'm going to say, a position like, ⁓ I think we're going to go long today. So at 1 o'clock, I'm going to buy a call for the end of the day. And if I'm uncomfortable losing my premium, so be it.
But what was driving the biggest volume in zero data expiration is credit spreads. So they would sell like a $10 widespread for three and a half bucks, right? Try to get nine wins out of 10 and then they'll lose $7 at one time if goes to 10. So that's a big driver. And then since we have the charts up, the next chart, think number four, this is specific to FLEX. If you look back on the far left in 2011,
It was, it was de minimis. And that's the time I basically started. was, you know, 2011 was like the, you know, I started technically 2010, but 2011. So I went in there with really no, no ammunition to say, this is going to be great, right? This is great. But we built it up. We built systems to accommodate it. And every year you could see it had growth, growth, growth and growth. Now what's interesting, if you go fast forward, if you look on the far right, 23, 2024, et cetera, you're going to see a
big surge in the single stock FLEX options usage. And that's because people realize that if they're going to do some kind of an options package that they're building, they don't want to have the early assignment or the exercise, correct? Because all of sudden, they're short, it gets hit, and they're stuck with the long, and now they've got some risk involved. But the biggest driver is that it's a reversal conversion. I don't know if you want to talk about what that is. It's arbitrage where you go long a combo, long a call, short a put.
which is a synthetic stock and you do it for $100. The stock's trading at 101. You sell that stock at 101, you in theory locked in a dollar. Now that's been expressed as in terms of interest rates right now. Cause if you see the growth in this is tied to the interest rates going up. So people are trying to create a interest rate play with this, right? So if they could do a reversal where the selling stock and garnering some sort of interest rate based on the price of the short put, this is why they do it. I know it's getting off the track, but
This is a big driver of the FLEX for the individual name using ⁓ European style. And then if you look at the ETFs in green, it's a lot bigger. But then you see this tiny thing here in aqua, that's the index volume, right? So when I first looked at this ⁓ chart, I go, that's not telling a true story because somebody that's not trained will look at it say, well, that means it doesn't trade. If you go to the next slide on five, if you do it by notional,
Now, the color scheme did change. I couldn't help that. So now index is the dark blue. But you can see up until 23, up until 24, it was bigger than all of them combined based on Notional. And now, you know, because the ETFs and the single stock names are really jumping. Now Notional is kind of a misnomer because if you're trading a lot of SPX, like again, you're trading a $5,500 index.
or the average stock might be $160. I don't know, I'm taking a guess. So it's just kind of, it's math. But I find it intriguing.
Howard Chan (29:34)
If
you go back to the total volume by type on FLEX I mean, it's pretty incredible that in just the first, I don't know, three months of 2025, you almost have by volume surpassed 2022 and closing in on 2023.
Bill O'Keefe (29:49)
Oh, yeah. Oh, 100%.
Yeah, right now we're averaging 1.4 million trades on an ADV. Now, I try to, I look back at some stats when I was trading when I thought it was busy. So I'm going go back to 93, 94. If you took at the average daily volume of at that time, there's four, there's five exchanges, right? So if you took all the aggregate ADV, was, was, that was what it was. So the FLEX market today was the whole option market 30 years ago. That to me, that's, that really blew me away.
Howard Chan (30:18)
Crazy.
Yeah.
Bill O'Keefe (30:19)
Although it looks de minimis, I think it's about 2 % of the business right now.
Dominique Tersin (30:26)
because,
Bill O'Keefe (30:26)
This is interesting because this shows the total open interest of FLEX. Now it kind of, right after 22, it just went straight up, right? And now obviously the single stock again is the biggest as well as the ETFs because a lot of the ⁓ ETFs have a duration of a year usually, and then they have a monthly cadence and they come in.
So, ⁓ same with single stocks, they're locking up for a certain amount of time in a revcon. this is another way of saying the market's really growing. Yes, and then one I like to talk about too. This you might find interesting, eight. Hard to read, especially the middle and the third, but these are the FLEX most active products. So, the SPX for FLEX is about 60%, two thirds of all the FLEX that's done on indices, and it goes down accordingly.
The second is the ETFs, little spider being almost 30%, right? 26%, TLT, HYG, et cetera. Then it just goes down from there. But I think if you guys are, if you're thinking about, you know, products and what's active and liquidity, this is a good barometer. You can see where there's activity. And then in the far right is the single stock names dominated by the, I would say the MAG seven ish names. And it goes down from there.
But one thing I like to say about liquidity, you because I think it's really, really important. This is about the evolution of the exchange and what has changed over time. Because what has changed over time with respect to the FLEX options, it was kind of ignored. It was small. When I was in it, there was no interest in it. I was begging market makers to quote for me and they did. There was about four that started. Now everyone wants in and now other exchanges are launching FLEX options. And, know, so.
It's here to stay.
Howard Chan (32:07)
Right.
I think, so in terms of, ⁓ let's maybe dive a little bit into FLEX Options. How is it priced and how is it different than listed option pricing?
Bill O'Keefe (32:15)
you
Well, at end of the day, it is considered a listed central court option. You know, it's fungible with the same names as far as collateral is concerned, all that stuff. But how it differentiates itself is, well, first of like I said, you cannot go on a screen and see what this odd strike is. So actually, you can customize the strike. And usually to two percentage points to the right, meaning that it matches the closing print. know, SPX holds it 54, 13, 79. You could have that strike.
Exactly. So like an insurance company, for example, they want to have a point to point, right? So if they're telling you, of today, the end of today on the 23rd of April to 23rd of April, 2026, we're going to benchmark the closing price today. That's going be a strike. So let's say it's 54, whatever, 54, 79, 13. That's how they do it. And that'll be at the money call. And then they'll sell some cap call on top of that one.
And then just that's the exposure. Same with the target outcome ETFs. They need, if you're promising a 10 % buffer a year from today on the 23rd of April, 2026, how are you going to do that? First of all, there's probably not a listed option out there, right? It's great. You can do this FLEX and you can do it. You can actually trade a FLEX in percent terms on the day you execute. So you could buy at the money or the a hundred percent put. You can sell the 10 % in money, out of the money, the 90 % put.
and that there's your buffer. And then based on that price of that buffer, you can finance it by selling some call. Well, the market maker that the highest call is going to win because it's going to illustrate better. if he says, I can be at ⁓ 117 % call, ⁓ OK. Another guy is, I'm at 118.50. I want the 118.50 because that's a bigger cap for me. This could be all done with these FLEX options. And again, to your point, European style, there'd be no early exercises or assignments.
Howard Chan (34:16)
Yeah, I mean, we use FLEX Options in our portfolios. And I actually have a question for Dom, which is, how has that made portfolio management in our portfolios easier or harder using FLEX versus Listed Options?
Bill O'Keefe (34:24)
Thank
Dominique Tersin (34:31)
Yeah, you're right. We use FLEX options ⁓ mainly as Bill said to avoid the earlier assignments. if we do a synthetic, so if we want to replicate the stock, we buy the call and sell the put.
Bill O'Keefe (34:32)
you
Okay. ⁓
Thank you.
Dominique Tersin (34:53)
If stock goes down, we will have a risk of assignment on the put side, which is not ideal. So to reduce the amount of trades that we have to do, FLEX is better on that side.
Howard Chan (35:07)
And I guess you mentioned it's sort of a quoting auction type way of ⁓ pricing it. I don't know if you could go in detail about, we know how we get quotes, but how typically the different participants actually price these out, especially since these are custom, right? So they have to have a model somewhere and how do they price these?
Bill O'Keefe (35:15)
Yeah. ⁓
So, know, the market makers, you know, in 2010, it was very manual. The market makers would say, give me 10 minutes, right? Well, now it's the turnaround time is wickedly fast. And then we would, as a broker, would, I would build, we build CSV files and kind of standardize that file that all the clients would use. The market would expect that trade request coming in on the CSV and they would put in like their pricing or their Delta reference to their, you know, the reference price and all that other good stuff.
And then it would be traded, headed back and forth, emailed back and forth. And then as a broker, you would pick the best price. The customer wants to buy something, well, the best lowest offer is going to win. So it was really quick. And now these guys, they're uploading. Some people are doing this in real time for Frick's Connection. So it's really efficient right now. And market makers are banging the walls down to get into this because they're not seeing everything.
especially newer market makers that weren't really focusing on FLEX they're getting into this game as well. So I think the liquidity is amazing. And I was making a comment earlier that I would argue that the pricing is commensurate with the listed market. And I would get dirty looks, or well, how do you explain that? I said, well, it's simple. mean, market maker A, B, C doesn't care that a listed market is showing $3 at 308. They don't care. They're looking at their volatility curve, what their exit grind is. If they have it worth 297,
they're going to be at 299 or what have you. So they're trading off their volatility curve. And what's interesting about FLEX on larger trades is how it works in the pit is you and I, the three of us could be making markets all day long, the same guy asking for the same thing. The only thing that's changing is the reference in the Delta is finally they come in with 20,000 to go and all the hands go up, me too, me too, me too. And then all that work for what? with FLEX,
the best price gets the entire trade. What an incentive. So if I was at $30, right, that's where I want to sell it. But I got, you know, I'm only a bunch of Vega one year out and I have this opportunity to sell a lot of this Vega that I need. I'm not going to be at 30. I'm going to improve on that price. So I think you see that kind of dynamic, which is sometimes in some cases, FLEX prices could be better.
Howard Chan (37:52)
Yeah, one of the questions I had, which you just answered, which is, you know, these are customized contracts, right? So in theory, it should be harder for the market makers to hedge because they there's the parameters are all very different, but you're you're right in saying that volatility is really what they're really focused
Bill O'Keefe (37:58)
exactly. It goes back to the original opening statements, right? Yeah.
Howard Chan (38:14)
Yeah.
I actually, and follow up question, as you mentioned, you know, obviously there are more more ETF issuers like us who are using FLEX and you know, whether it's buffer ETFs or cover call ETFs, how has that changed sort of the dynamic of this market? Because, know, if you're a cover call ETF or a buffer, you have to be naturally short vol, which
Bill O'Keefe (38:30)
you
Howard Chan (38:42)
potentially has not really been there. There's like a mainstay in the market. ⁓ And then you're doing, there's all these synthetics. there's a natural seller of puts and buyers of calls. How has the mix of risk and maybe market participant behavior in the market, in these options market changed since there's been more more ETFs that use options in the market?
Bill O'Keefe (38:47)
Thank
Yeah, I just had an analyst run the AUM. ⁓ The AUM between the overwrite funds and the buffers at $203 billion, with the buffers being $62 billion. Now, there was a very small drawdown of funds, very small, but these are all-time highs still, this AUM. So I think it's working as told. So the buffers, they protect it.
If we're down 9%, you didn't lose any money if you're in one. You didn't make anything. In fact, you still have to make that back before you get back to par, before you start making money. A lot of people think, oh, I can buy a... Right. A lot of people think, okay, well, this buffer that is a 10 is down nine. I'm going to buy it now. And then I started zero. It doesn't work that way. So you still have to get those winnings back before you get to par. Then you'll participate to the cap.
Howard Chan (39:40)
Yeah, it's very path dependent, right? Yeah.
Have you
seen a change in the nature of volatility in the options market? Because now you have, I don't want to say non-economic, but natural buyers who are long vol and then there's natural people who are shorting vol consistently. It's not just like event driven. Have you seen any changes in the dynamic there?
Bill O'Keefe (40:14)
You know, I really haven't. mean, because I think the market makers that are in this space and this whole ecosystem of, you know, being providing liquidity for these either overwrite funds or the buffer funds, this is part of their business, right? I mean, they're they're great at hedging. They have great tools. They're very sophisticated. They're trading around the globe. They're trading futures. They're trading all sorts of unrelated and related asset classes to hedge. I mean, that's what I've seen. I just haven't seen too much disruption.
from the competent market makers that we see on a daily basis here.
Howard Chan (40:48)
Yeah, I've heard a few ⁓ podcasts where they actually say the market is a little bit more defined because ⁓ the nature of the people who are either natural short vols or makes it a counter cyclical loop if there's a sort of a correction in the market.
Bill O'Keefe (41:09)
Yeah, yeah, I agree
with that.
Howard Chan (41:13)
Okay, Dom, do you have other questions?
Bill O'Keefe (41:14)
Okay.
Dominique Tersin (41:19)
Maybe on the market participants. So what I understood is the one who you use FLEX or like Kurv, the ETF, who use options. You have the insurers who might have particular needs. Any other?
Bill O'Keefe (41:29)
One minute to go.
Mm-hmm.
Yeah, well then you have ⁓
the people that are doing an arbitrage, trying to lock up an interest rate. They will do it with a reversal conversion. Again, to Howard's point is, they're not going to use American style equity names. They're going to use FLEX and change it to European. So those are the primary, the three biggest ones. And I'm sure, obviously there's some people that want to white label, what we call do it themselves. These are like family offices or big IRAs.
They might just do it in an SMA and I don't see it. You're not seeing it because it's not in some fund or name fund. So, you know, they might be employing these kinds of options strategies and it's hard to track those, but they're out there.
Howard Chan (42:19)
OK. Well, that was really loud. ⁓ Well, that is an amazing, that was actually a great recap of both the history of the option markets and also what's been happening in recent times. The development of both listed and now this new FLEX options, which
Bill O'Keefe (42:21)
One, two.
Yes.
Howard Chan (42:47)
We, ourselves, users of it, really appreciate all of the features. Before we leave, I'm sure, I'm curious, Bill, do you have anything else that you want to impart to our audience?
Bill O'Keefe (42:58)
You know what I think if they want to learn more about this, you know, the CBOE website has a wealth of information and knowledge and education. And we even have indices that reflect an overwrite strategy. You know, we have a put write, we have a call write and SPX, we have them for both Russell. And so it's a good way to see to kind of track an idea and look at things. And there's a lot of things that explain everything, right?
So yeah, there's actually a SPRO index, which is a 10 % buffer done every month. And it's one of the big issues is following that cadence. So you can kind of see historically back to, I think 2006, how a 10 % buffer performed over various volatility regimes.
Howard Chan (43:41)
Yeah, and I just want to echo that. There's a lot of really great resources on cboe.com, which for us, we look at historical volatility to kind of define what the range for some of our strategies are. There's a lot of good insight in terms of people just actually gleaming what's happening with volumes and what's happening in the market that's very useful for managers like us as well. well, thank you so much, Bill. This has been really insightful ⁓ and we hope... ⁓
you are first guest, but not the last. And maybe you'll join us in the future for another.
Bill O'Keefe (44:11)
hey, all right. Well, absolutely,
I'd love to. Thanks a million for having me. I appreciate it a lot. All right, take care. All right, goodbye.
Howard Chan (44:18)
Okay, great, thank you.
Dominique Tersin (44:19)
Thank very much.
Recorded 4/23/2025.This material contains the opinions of the speakers, and such opinions are subject to change without notice. This content is not to be considered as personalized investment advice or a recommendation of any particular security, strategy or investment product.