Interview: Cathal Hardiman about options on iShares ETFs, how they fit into your business and more

Eurex: Thanks for sitting down with us today. Could you please start by giving us a bit of background about Susquehanna and your role?

Cathal Hardiman: Susquehanna was founded in 1987 as an options Market-Making firm in the U.S. Since then, we have grown to employ over 1,500 people worldwide, with over 300 in our European headquarters in Dublin. We have expanded to cover a range of product types, and are currently among the largest Market Makers in Europe in both the ETF space and the options space.

I work on the options sales desk in Europe, which acts as the client-facing arm of the options desk. Our client base includes asset managers, hedge funds and bank execution desks. We cover the vast majority of listed options in Europe, and make commission-free prices for clients who come to us directly.

Eurex: How do Eurex Exchange derivatives fit into your business?

Cathal Hardiman: We act as liquidity providers across all major European exchanges. Eurex Exchange is the largest market in terms of traded volume, and we are very active as liquidity providers in this market. Last year, we were responsible for 16 percent of all listed options volume (index & single stocks) traded on screen in Eurex (10 percent overall).

We work closely with Eurex Exchange on new product listings, acting as the primary Market Maker / liquidity provider on several new product launches. Apart from the new ETF options, we have worked with Eurex on the launch of weekly options (both index and single stock) and sector options, and all three new product types have since seen considerable interest.

Eurex: Eurex Exchange offers index options in many flavors. What is the appeal of ETF options?

Cathal Hardiman: ETF Options provide an alternative to regular index options in a number of key areas: First, they are physically settled, which allows for netting of positions versus ETF holdings. Regular index options are cash-settled so do not allow netting.

Dividend treatment for index ETFs is very different from that of regular index futures, so ETF options provide a much better hedge for this ETF dividend exposure.
ETF options are American-style exercise, which allows investors more flexibility with their position compared to the European-style index options.

Finally, lot sizes are smaller on these products, with 1 lot of a regular SX5E option (EURO STOXX 50® Index Options) is equivalent to 10 lots of EUN2 options (options on iShares EURO STOXX 50® ETFs). This could suit smaller investors better, as 1 SX5E option is about EUR 30,000 notional.

Eurex: In the U.S., many of the most liquid options are based on ETFs, not just Spider ETFs on the S&P 500. Is this liquidity development possible in Europe as well?

Cathal Hardiman: ETF options have seen incredible growth in the U.S., with roughly 35 percent of all U.S. listed option volume in 2014 made up of ETF options. We believe that the European market has the potential to get to this level. In terms of new product development, Europe generally tends to lag the U.S. by a few years. For example, weekly options are now well established in the U.S. market place, accounting for 25 percent of total volume. Weeklies in Europe are starting to catch up. With SX5E & DAX® weeklies the most mature markets, weeklies now make up over 6 percent of the total in both.

ETF options are very much in their nascent phase, only being quoted by us from the beginning of this year. With Susquehanna committed to providing liquidity and promoting trading in the product, we believe that these ETF options have a fighting chance of seeing growth similar to what we have seen in the U.S..

Eurex: ETF options on iShares now trade with pro-rata matching at Eurex Exchange. Where do you see its merits, for example versus price/time matching?

Cathal Hardiman: One of the key differences between the U.S. and European market is the prevalence of pro-rata matching. The majority of U.S. listed options flow trades via pro-rata matching, with Europe lagging in this respect. Under price/time priority, a Market Maker who is not best bid (say) has no incentive to step up and join, since they only get filled when the size is large enough to take out the first bid, and they miss out on all of the smaller, more benign flow. With pro-rata matching, there is an incentive to join top-of-book (TOB), which leads to more visible liquidity on the order book.

The contrast can be seen by comparing a European name with its ADR. U.S. markets tend to be similar width but have up to 10 times the size on TOB compared to Europe. This gives investors more confidence in levels and promotes trading, which in turn leads to more size displayed on screen. This ‘virtuous cycle’ of liquidity is especially important for new products such as these.

Eurex: As Market Makers you provide liquidity with quotes in the order book. What recommendation do you have for institutional clients looking to transact in bigger size?
Cathal Hardiman: The liquidity displayed on screen is more like a lower bound for what is available. If a client contacts us directly, we can generally show more liquidity than what is on screen, both by showing more size than what is on screen, and by coming inside screen quotes for smaller sizes. The reasoning behind this is that our on screen quotes are our prices to trade with any anonymous counterparty. When we know who our counterparty is, that informational asymmetry is gone and the risk on the trade is reduced. Contacting us directly for better liquidity is advisable particularly for new products such as these, but also for all names across the European options spectrum.

Eurex: Thank you very much for sharing this with us, Mr. Hardiman.