BANK OF AMERICA AUTOMATED EQUITY OPTIONS GAINING TRACTION.

A new survey conducted by Financial Insights, an IDC company, and sponsored by Bank of America suggests dramatic growth in the number of equity options contracts traded electronically in the years ahead. While equity options account for a minority of total electronic trades, the convergence of heavier trade volume, better order entry tools and increased education are likely contributors to this expected growth. The survey of head traders at 30 buy-side institutions is believed to be the first attempt to gauge buy-side trading practices in equity derivatives, including the adoption and usage of electronic execution tools.

The findings point to a relatively high market penetration for automated options trading. Sixty-one percent of respondents indicated that they traded some portion of their options holdings electronically, compared with just 39% who rely solely on the telephone. Respondents who execute electronically tend to be repeat users, trading more than 70% of their total order flow in an automated fashion.

"There are nascent technologies being developed that could do for options trading what algorithms did for equities," said Dean Curnutt, head of institutional equity derivative sales for Bank of America. "The survey suggests that options desks are beginning to embrace these new technologies and that the promise of greater profitability and productivity will continue to fuel demand."

Bank of America is already seeing some of this firsthand, as its top-rated InstaQuote(R) platform, a cutting-edge trader workstation with an integrated suite of order management, analytic, and portfolio maintenance capabilities, surpassed 6,000 users worldwide.

"The survey results suggest that growing buy-side interest in options as an asset class has increased both trading volume and demand for execution quality," said David Cox, Chief Research Officer at Financial Insights. "With volume having more than doubled in the past five years, options markets are finding faster, more cost-efficient methods of execution."

As equity options become more popular among investment firms, Bank of America sponsored the survey to reveal more about how they are traded. Among the principal findings from the survey conducted by Financial Insights:

Significant Growth Potential

The survey suggests that options trading is still a relatively specialized niche. Respondent firms averaged four traders, only two of which were dedicated to equity options. Given the recent explosion in options volume, however, it came as a surprise that six in 10 had less than 10% of their assets invested in equity derivatives. With 100% of firms estimating that their equity options volume would either increase or stay the same during the upcoming year, the growth potential for this asset class remains significant.

Basic Options, Strategies Dominate

Despite the growing complexity of options contracts, much of the recent spike in volume can be attributed to simpler types of contracts. Nine out of 10 respondents traded single-name equity options, with this percentage varying inversely with complexity: 78% traded equity index options, 64% traded ETF options, 25% worked with European options, and only 14% had experience with options on index futures. With regard to specific strategies, long/short and volatility trading were the most widely practiced, while equity pairs, capital structure, and proprietary strategies accounted for just a small fraction of equity options investments. In addition, 55% of respondents used options for hedging, as opposed to speculation, although speculators tended to amass much higher trading commissions, on average, than hedgers.

Smaller Firms Leading Transition

Trading technology in options markets is unfolding in much the same fashion that it did in equities with one interesting difference -- whereas technological innovation in stock markets was generally precipitated by larger firms, smaller firms with $500 million or less in assets are leading the transition in options markets. The likely reason is that smaller firms, especially hedge funds, tend to have fewer traders than their larger counterparts.

Functionality Critical to Adoption

Respondents listed certain functionalities as critical to their future reliance on electronic trading of options. According to the survey, the two most desired features of any electronic trading platform were the ability to execute multi-leg orders (practiced by 61% of those surveyed) and the inclusion of a smart-order routing capability. Smart-order routing technology is currently available, and a majority of those surveyed (63%) stated that it improved their efficiency. Participants ranked convenience, price improvement, and productivity as the three most valuable features of smart-order routing technology. Bank of America was among the first to offer smart order routing when it made the technology available through its InstaQuote platform earlier this year.

Education Crucial

The pace of innovation in options markets has resulted in some anxiety and confusion among buy-side traders. Generally, participants tended to perceive themselves as less proficient than was often the case. For example, those that ranked themselves three out of five on the sophistication scale were actually employing a greater variety of trading strategies than those that ranked themselves higher. More widespread was the lack of understanding of certain analytical tools designed to optimize execution quality. A minority of those surveyed (42%) reported using pre-trade analytics, and only 55% worked with programs that could diagram profit and loss scenarios. Portfolio analytics fare better, with 86% reporting that they regularly used software to evaluate portfolio performance and the Greeks. To alleviate trepidation around new technology, Bank of America has maintained its commitment to enlightening the market about electronic trading through sophisticated technological support, educational events, and surveys such as this one.

Methodology

The survey was administered by phone to a random sample of head traders from 30 U.S. buy-side firms. These included hedge and pension fund managers, brokerages, and other investment firms with managed assets between $50 million and $10 billion. Respondents were asked a series of 73 questions on firm positioning, brokerage relationships and trading practices with regard to equity options.

About Bank of America

Bank of America (NYSE:BAC) is one of the world's leading financial services companies. The company's Global Capital Markets and Investment Banking group (GCIB) provides investment banking, equity and debt capital raising, research, trading, risk management, treasury management and financial advisory services. Through offices in 35 countries, GCIB serves domestic and international corporations, institutional investors, financial institutions and government entities. Many of the bank's services to corporate and institutional clients are provided through its U.S. and UK subsidiaries, Banc of America Securities LLC and Banc of America Securities Limited.

For more information, visit http://www.bankofamerica.com or call 312/988-2046.

About Financial Insights, an IDC Company

Financial Insights provides independent research, custom consulting, and detailed multiclient studies on the technology issues and challenges facing the financial services industry. Our global research covers topics of strategic importance to corporate and retail banks, insurance carriers, asset management firms, securities and brokerage firms. Our local practices in Asia Pacific, Europe, Latin America and Canada add an in-depth regional viewpoint. Financial Insights, an IDC company, is headquartered in Framingham, Massachusetts, USA. IDC is a subsidiary of IDG, the world's leading IT media, research, and exposition company.

For more information, visit http://www.financial-insights.com or call 508/935-4318.