Cashing In on Volatility Has Been Tougher Than Expected for Cboe

By Gunjan Banerji 

Chicago-based Cboe Global Markets Inc. is trying to convince investors that new products and a technology upgrade can pull it out of a year-long share-price slump.

Shares of one of the country's oldest and biggest options exchange-operators have tumbled 23% since the start of last year to become the worst-performing U.S. exchange-operator in that period. Rivals CME Group Inc., Nasdaq, Inc. and Intercontinental Exchange Inc. gained at least 3% during that time.

The question now is whether the exchange-operator can branch out beyond its marquee product, the Cboe Volatility Index, or VIX -- a widely watched gauge that tracks expectations for future market turmoil -- and its derivatives. The company's stock hasn't seen the boost from market turbulence that many expected. And how well Cboe can capitalize on a coming shift to newer technology remains to be seen, analysts say.

Few companies are as poised to benefit from market volatility as Cboe, leading some investors and analysts to say it may be a good time to dive back in. The company is undergoing one of the biggest transformations in decades, moving to new technology and potentially shifting its headquarters.

"It's a pretty good time to take a look at Cboe," said Mike Bailey, director of research at FBB Capital Partners, who owns shares of competitor CME. He said the company's valuations have gotten so low that it is becoming more attractive to buy, but investors need to be prepared for severe swings in the shares.

One issue giving investors pause is the slide in trading volume of some of its lucrative VIX options and futures, which are sharply down from 2017 and 2018 averages. Average daily futures' volumes hit at least a two-year low in February after claims of their manipulation and a collapse in trading of exchange-traded products linked to them clouded the product last year. The futures volumes have rebounded slightly in March, as have options volumes.

More generally, assets sitting in exchange-traded products linked to volatility have also fallen since the beginning of 2018, FactSet data show, potentially leading to less activity in Cboe's proprietary products. Those types of ETPs were wildly popular as a way to execute the so-called short volatility trade before it took a beating last February, and spurred activity in other wagers linked to market swings.

Several analysts said they expect muted growth in the VIX volumes in 2019. However, trading could pick up in the long-term, especially if market turbulence persists, they said. A spokeswoman for Cboe said that traders use S&P 500 options, another key proprietary product, interchangeably with ones on VIX. She said that though VIX options trading receded in 2018, VIX futures and S&P 500 options had record years.

Christopher Harris, an analyst at Wells Fargo Securities following exchanges, said that despite recent setbacks, he is optimistic that Cboe's proprietary products will continue to drive growth in Cboe's share price.

"We like the stock," he said. "As much as the [VIX] products have grown...I don't think they're fully mature yet."

But some worry Cboe is overly reliant on VIX and S&P 500. Cboe Chief Executive Edward Tilly used to repeatedly ask his product development team what they could "VIX" next, said people familiar with the discussions.

"Cboe looks more like a one-trick pony," Mr. Bailey said. "You're basically betting on VIX and S&P options."

The Cboe spokeswoman said the company sees "significant opportunity ahead" in the volatility space. Ongoing product development, including for VIX products, is a cornerstone of its growth strategy. She said the company is "focused on driving long-term shareholder value" and through 2018 Cboe outperformed the S&P 500 over the past five years.

Cboe said this month that it would join with index provider MSCI Inc. to launch volatility indexes based on international stocks. But it can be tough to strike success with new wagers: Cboe recently decided to abandon bitcoin futures, launched in late 2017, amid lackluster trading volumes. Corporate bond futures, which it introduced in the fall, have recorded less than 100 trades a day on average. Its successful products can record hundreds of thousands of trades a day. Cboe said this is normal for a new product.

The company should finish moving its technology to Bats Global Markets', the upstart exchange it bought in 2017, later this year. The tie-up transformed Cboe into a behemoth in both stocks and options and opened the door for it to make its old-school floor-trading culture more technology-savvy. The move will bring a long-needed upgrade to Cboe's antiquated platform and allow faster and more frequent technology updates.

Better technology can also spur volumes in VIX and other products, analysts said. Moving options trading on the S&P 500 index to a so-called hybrid platform that blends open outcry and electronic trading stoked more trading in them.

"People should be really excited about what Bats technology can bring to Cboe," said Joanna Fields, founder of Aplomb Strategies, Inc., who once worked on Cboe's options trading floor in Chicago.

In the latest sign of change at the company, the exchange-operator recently said it could move its headquarters, where it has been since 1984, to someplace else in Chicago. Though floor trading has dwindled across the country, old-fashioned hand signals and shouting still dominate the trading floor for S&P 500 and VIX options at Cboe.

Chris Isaacson, the new chief operating officer, oversaw a transition to an all-electronic pad for tracking orders. Until recently, floor brokers at Cboe were using decade-old technology to record options orders executed through the open outcry pits.

Write to Gunjan Banerji at [e-mail]

(END) Dow Jones Newswires

March 24, 2019 09:14 ET (13:14 GMT)

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