Retail brokers in Europe poised to expand derivatives as regulatory challenges mount

Changes are afoot in the derivatives industry as retail brokers in Europe evaluate a shift towards institutional markets and listed futures and options due to increasing regulatory constraints.

This is particularly in response to the potential expansion of restrictions on Contract for Difference (CFD) markets. Spain’s recent restrictions on retail-focused instruments have caused concern among retail brokers, reflecting similar actions across Europe.

According to a recent Acuiti study commissioned by ION, 77% of retail brokers plan to expand into other regions, 69% aim to grow in institutional markets, and over half intend to offer futures and options as alternatives to Over-the-Counter (OTC) retail instruments like CFDs.

Listed derivatives markets in the US have shown how they can cater to retail with the launch of smaller-sized contracts and so-called zero-day options – the two fastest growing segments across global markets. Similar products have been launched in Europe and are gaining in popularity, the survey showed.

To broaden their offerings, brokers plan to invest in technology across their trade workflow.

What are the opportunities and challenges of an expansion in retail derivatives trading? And what’s the picture in the US and Asia?

Zero-day options make their mark

Look up zero-day or end-of-day options in news headlines and you’ll come across some eye-catching headlines: from ‘degenerate gambling’ to ‘shadow of the apocalypse’ and ‘clueless Wall Street’.

Nevertheless, zero-day options (or 0DTEs), regular options on their last day before expiration, have become a popular trading tool for retail investors in the US. Such derivatives can yield big profits but also carry significant risks due to their short lifespan.

In the US their popularity has surged, with a 60% increase in contracts opened on the option’s last day between January 2022 and January 2023, according to the Financial Industry Regulatory Authority (FINRA) in June 2023. Retail traders increased their zero-day contracts by 75% over the same period.

David Howson, president of Cboe’s European business, said last month in his post ‘Bringing Cboe’s U.S. Retail Playbook Abroad’ that last year’s record overall volumes for the US listed options industry were driven by ETFs (up 12% year-on-year) and index options (+33% year-on-year). Much of the growth in the latter was in 0DTE trading, with 30% to 40% of the flow in S&P 500 (SPX) options coming from individual retail traders.

Is Europe catching up in retail Derivatives?

Until now in Europe, retail trading in derivatives has not been as popular, but things are changing.

Eurex, a derivatives exchange run by Deutsche Börse, last year introduced 0DTEs options based on the current EURO STOXX 50 options market, following their sharp growth across the Atlantic.

The introduction might be a watershed moment.

For Cboe’s Howson, ‘The same expansion of mobile-enabled fintech brokers that we experienced in the US is happening in Europe’. US firms are looking beyond the intensely competitive US markets and the opportunistic are focused on Europe. This is also attracting European-based brokers, domestically grown entities, to also make their mark by entering the retail space.

Crucially, Howson says, ‘the zero-fee trading that helped drive retail growth initially has become a mainstay of these platforms, continuing to provide an incredibly low—or no—barrier to entry’.

APAC is where the growth is

Headlines from Europe and the US sometimes squeeze Asia Pacific (APAC) regional issues out of the spotlight, but it’s increasingly clear that this region is where the action is, said Walt Lukken, the president and CEO of the Futures Industry Association (FIA), in November.

According to the trade body, the total volume of futures and options trading in APAC increased 104% from 2022 to 2023, with options trading on Indian exchanges being the significant driver. Total volume in Europe by contrast rose 2.6% to 4.9 billion contracts.

Volume in Asia is expected to continue, and it is attracting more trading firms from outside the region.

A study by Acuiti in September revealed that European proprietary trading firms and hedge funds are planning to expand trading in the region. The survey of 53 European firms found that 59% traded derivatives in APAC, with another 11% planning to start. Some 37% of respondents found trading there more profitable than in Europe.

Firms trading Indian onshore markets reported the highest profitability and equity futures were seen as the asset class with the most potential in APAC over the next three years.

India goes options crazy

Zero-free trading, technologically savvy retail brokers and small investors, influenced in no small part by social media, have also combined to drive the popularity in India for derivatives trading.

India’s ETD volumes have grown more than 10-fold since 2017 to roughly 60 billion contracts traded in 2023, the FIA said late last year.

India has become a major derivatives marketplace. The country’s financial markets have undergone significant transformation and retail investors are broadening their scope beyond the traditional equity segment.

Trading in derivatives has gained popularity due to its potential to generate significant returns with relatively small investments. Regulatory improvements and enhanced market transparency have also facilitated growth in retail participation.

This shift has led to a boom in retail trading, doubling the derivatives turnover at the National Stock Exchange of India to $5.04 trillion based on a 10-day moving average.

This surge is part of a retail trading boom that has driven India’s stock markets to new highs this year. Retail investors now account for over 25% of the average daily turnover in derivatives, with over 8 million individual investors trading in this segment in 2023, a 30% increase from 2022.

The rapid growth has made authorities nervous, with the Securities and Exchange Board of India (SEBI) beginning last year to look at ways to bolster risk management.

Addressing risk, leveraging technology

Beyond the inherent risk of retail investors losing money, some market participants have raised concerns that 0DTEs could impact longer-dated option liquidity and increase system risk.

But Eurex says, in reference to the spike in SPX option trading in the US, that most of the volume has been additive to the market and not hurt longer-dated option liquidity. Additionally, ‘due to central clearing and stringent risk monitoring by brokerage firms, it is doubtful that short-dated options may be the cause of the next headline-grabbing market event.’

In terms of technology, industry body FIA says technological developments have resulted in improved access to markets for institutional and retail traders.

Moreover, brokerage firms are now studying the opportunities afforded by artificial intelligence (AI), including building customer enhancement features, and improving middle and back-office operations and risk controls.

In Europe, according to the Acuiti study, retail brokers plan to spend on technology to improve their workflow processes as they expand the products and markets they offer.

The most common areas for investment include trading, risk management, reconciliations, and straight-through processing to achieve front-to-back efficiency. Currently, half of the firms that anticipated a requirement to invest were planning on building in-house, while over a third were planning a mix of outsourcing and in-house builds.

Whatever the technology route taken, if there is an uptick in derivatives trading fueled by retail trading, now is the opportune time for brokers to invest to increase scalability and resilience to meet client demand.