ICE,NYMEX war on collars,calls,condors

* Strong growth seen in electronically traded options

* Commodity index shift may be behind Brent options gains

A growing force in energy markets,options probably played a role last Thursday when crude prices plunged on waves of selling that crashed through strike levels,causing more losses.

The Intercontinental Exchange has struggled to make inroads on a lucrative niche long dominated by arch rival CME Group’s New York Mercantile Exchange. But four months of intensive marketing and incentives,and a rising share of electronic trade,may be tilting the balance.

Both exchanges have been aggressively growing over the past decade,with ICE and Nasdaq making an unsolicited offer for NYSE Euronext on April 1.

It is a big business for NYMEX — options account for 21 percent of the volume of the exchange’s energy futures trading — but only accounts for about 0.2 percent of energy trade volumes for ICE.

Ironically,the NYMEX’s decision to retain its trading floor in the computerized trading era has helped it defend its turf as participants build complex strategies through complex option plays with names like butterflies,guts,collars,strangles and condors. Algorythmic trading giants struggle to execute these complex options deals as efficiently as the pros on the NYMEX floor.

But they are getting closer. Electronically traded NYMEX energy options now eclipse open-outcry activity,up from less than one-quarter a year ago. That could eventually open the door for ICE to grab significant energy trading market share from its rival by offering better prices.

It would mark another victory for the upstart exchange whose benchmark Brent crude and Rotterdam gas oil futures contracts are growing far more quickly than NYMEX,drawing liquidity from new fans in funds and firms. Concerns about the NYMEX oil futures,which have increasingly reflected the fundamental conditions of the U.S. Midcontinent delivery point of the contract,have helped push trade to the ICE.

Some prominent market makers have now started making markets in ICE options that have languished at nearly zero for years,according to Michael Korn,a former floor trader who now runs New Jersey-based options broker Skokie Energy.

I’ve seen some movement over to the ICE options market by some of my old mates from the NYMEX floor the last few months,he told Reuters.

High options traffic has helped keep the NYMEX trading floor alive,as the majority of oil futures trading is done electronically,in offices that can be thousands of miles away from the exchange.

But even as the image of oil trade shifts from a pit rammed with hundreds of traders barking orders to that of a silent screen,the few of the old guard that still muster on the floor daily have a strong hold on the options trade.

Simple,plain vanilla options like puts and calls can be easily be traded electronically,but complex options structures remain the domain of the floor.

The percentage of NYMEX electronically traded crude options surged from a low of 5 percent in January 2008 to a high of 78 percent in February of 2011. For April 2011,that percentage has drifted back down to 63 percent.

Options traders said the migration to electronic trading means an inevitable silencing of the pit,however,as more complex electonic options are introduced. The choice between the ICE and NYMEX platforms may come down to which exchange offers the most opportunity,the most liquidity,and the lowest cost.

LOWER COSTS

ICE,and its London predecessor,the International Petroleum Exchange (IPE) have long offered crude options,but trade was minimal owing mainly to a lack of interest among brokers,according to Korn,who tried,and failed to make markets in IPE Brent options in the 1980s.

It has been a long,hard slog for ICE,but market players said lower fees may be swaying some traders. Many customers are said to be cost conscious considering the recent financial climate,so getting a price break on exchange fees helps.

Doing business on ICE is less expensive than on NYMEX,where exchange fees amount to $1.25 per lot on ICE versus $2.50 per lot on NYMEX,according to brokers.

While these fees are not new,brokers report they are being made more aware of the differences between the two exchanges through more aggressive marketing.

ICE also offers brokers an incentive,paying them monthly for bringing in business,while the NYMEX pays quarterly. Ultimately,though clients direct where trades are done.

I would have expected ICE to have taken more market share from NYMEX considering how much effort they’re putting into it,said Chris Jarvis,senior analyst and founder of New Hampshire-based Caprock Risk Management,a risk consulting and money management firm.

ICE has seen options trade volumes skyrocket,from just 875 contracts in early 2010 to 504,640 in the first four months of 2011. Still it is just a fraction of the deals done on the NYMEX,which a total of 8.71 million contracts traded in the first quarter of 2011,up 27 percent from a year ago.

NYMEX options volumes surged in 2008,peaking at just over 3 million contracts in May,before tumbling to 1.66 million contracts by December. The swing traced the steep rise and precipitous fall of crude prices from a record $147 a barrel to below $33 that year.

The peak and decline in 2008 volumes coincided with the collapse of investment banks Lehman Brothers and Bear Stearns,both reportedly into crude options,as well as hedge fund Amaranth and the bankruptcy of storage and pipeline company SemGroup.

OPTIONS MIGRATION

Despite ICE’s relatively low volumes,increasing numbers of crude oil options traders are finding the exchange has placed the welcome mat out for them.

Brent has traditionally played second fiddle to WTI in terms of contracts traded,but over the last year it has emerged as the world’s benchmark crude contract.

Roughly two-thirds of the world’s production prices against it. As NYMEX futures become increasingly tied to regional U.S. inventory conditions,Brent’s challenge to WTI has grown.

Brent volumes rose 38 percent in 2010 over 2009. Several times this year they have surpassed the NYMEX contract. Market share has grown due to shifting trading dynamics toward Asia due to growing Chinese demand,as well as moves among commodity indices away from the NYMEX contract to Brent.

The key issue in this shift is the landlocked nature of the U.S. crude benchmark and the market’s desire for options that reflect more real-world crude economics,according to Jan Stuart,Global Energy Economist at Macquarie Bank in New York.

If NYMEX wants to keep its options market share,it’s got to fix the futures contract,he said.

Both exchanges are moving to offer more exotic options electronically. Unlike basic calls and puts,exotic options such as straddles,strangles,and collars are more difficult to trade electronically as they can be hard to standardize and execute as a single transaction.

NYMEX offers Average Price Options and Calendar Spread Options,which allow for some of the more complicated structures to be done as a single transaction. ICE currently offers these products only on an over-the-counter basis,but will likely offer them on the main platform once its volume grows,according to the exchange.

Ultimately,it all comes down to cost and depth,a veteran options trader said.

Whichever platform offers traders the lowest cost structure and liquidity,will win this battle.