CBOE’s Extended Trading Hours (ETH) offers trading in the Exchange’s flagship SPX, SPXW, and VIX® option products beginning at 8:00 a.m. London time. CBOE made ETH available in March 2015 and has seen significant growth in 2017. Liquidity has continued to improve and has most recently dramatically increased with the entrance of two London-based dealers willing and able to commit capital to trades. Average daily volume has jumped from 4,400 contracts in 2016 to 7,500 in 2017, a 70% increase. August is on pace to be the best month of 2017 as CBOE is averaging over 12,000 contracts per day during ETH.
ETH growth has been strong, but a challenge to increasing volume even further has been a common perception that liquidity is poor. CBOE recently conducted an analysis to test the validity of this perception. The analysis revealed that ETH liquidity is much stronger than expected. Indeed, large institutional trades are frequently executed at levels that are generally commensurate with quality experienced during regular U.S. trading hours (RTH), (2:30 p.m. – 9:15 p.m. London time).
Our study examined 211 large trades executed in ETH during 2017. These trades represent 60% of the volume traded in ETH from 3 January 2017 – 15 August 2017.
The 211 examined trades included both simple and complex orders in VIX options, SPX options, and SPXW options. Various electronic execution methods were used to complete these orders:
- Simple orders executed against the screen bid / ask
- Complex orders executed in the Complex Order Book (COB) or the Complex Order Auction (COA)
- Facilitated paired orders executed via CBOE’s Automated Improvement Mechanism (AIM), for both simple and complex orders
DOES IT PAY TO WAIT UNTIL THE U.S. MARKET OPEN?
When considering ETH, a common claim among investors is that better liquidity and / or execution prices can be attained during regular U.S. trading hours. We challenged this notion by examining these 211 large ETH trades, asking what the execution price would have been had the trades been held until the U.S. market open. We categorized the estimated results into three distinct buckets:
- Trades favourable to ETH execution
- Trades indifferent to ETH / RTH execution (i.e., same execution price)
- Trades favourable to RTH execution
As predicted by the random walk theory, roughly a third of the trades fell into each category, thereby significantly diminishing the notion that better executions are attained by waiting until the U.S. market open.
However, ETH and RTH are by no means equal. Eliminating the trades where we estimated that there would have been the same execution price, the amount of money represented by the estimated price improvements on favourable RTH executions exceeded the amount of money on the estimated ETH favourable executions. Moreover, execution time is slow during ETH relative to RTH, especially towards the beginning of the ETH session. Lastly, the size displayed on the bid / ask tends to be much smaller during ETH. But the smaller displayed size does not seem to severely impact the amount of business that can be executed – liquidity providers are responding to large orders with large size.
While RTH seems to hold some advantages, ETH presents important opportunities. Specifically, ETH offers market participants the opportunity to react to sudden changes in implied volatility sparked by global events during non-U.S. trading hours. A recent example happened on August 29: North Korea fired a missile that travelled over Japan, causing spot VIX to spike 27% in early European trading hours. These gains in spot VIX were largely eliminated by the U.S. open at 2:30 p.m.
Effective spreads are generally converging between ETH and RTH, indicating that the execution experience in both sessions are becoming similar. ETH effective spreads are especially strong in SPX/SPXW. Earlier in 2017, ETH market participants were experiencing effective spreads as wide as $0.80, while RTH market participants typically experience effective spreads of about $0.30. But now, market participants are experiencing effective spreads of roughly $0.30 in both ETH and RTH.
ETH effective spreads are not as strong in VIX options, but are getting better. RTH VIX option effective spreads typically run in the $0.03-$0.04 range. At the beginning of 2017, ETH VIX option effective spreads were over $0.20, but now are lower than $0.10.
PLANS FOR CONTINUED IMPROVEMENTS TO ETH LIQUIDITY
CBOE has created a robust price discovery environment within our ETH session, with eight market making firms actively quoting in VIX options and six consistently present in SPX/SPXW options. While a few market makers garner a significant portion of the flow, no single market maker is capturing a majority, which indicates that liquidity-providing firms are vigorously competing to win trades.
Existing ETH liquidity is strong. Nevertheless, CBOE is working to further improve the ETH trading experience for customers. The Exchange is working to expand the number of London-based dealers that are actively committing capital to ETH trades so that customers can source risk prices from additional counterparties. In addition, CBOE is considering enhancements to market maker incentive programs that could result in tighter bid / ask spreads with greater displayed size.