Volatility Can Be Good
The recent increase in market uncertainty has caused a spike in trading volumes across equity, fixed-income, and derivative markets. This jump in volumes follows an extended period of historically low market volatility in U.S. equity markets. We believe the primary beneficiaries of increased market volatility are the financial exchanges, which derive their revenue directly from trading volume.
A number of the large financial exchanges, including the Chicago Mercantile Exchange (CME; ranked 3 STARS, hold), CBOT Holdings (BOT; ranked 3 STARS, hold), and NYSE Group (NYX; ranked 4 STARS, buy), saw record trading volumes as the market sold off on Feb. 27. Standard & Poor's expects the strong trading activity to continue in the near term.
Equity market volatility, as measured by the Chicago Board Options Exchange Volatility Index (VIX.X), a widely watched measure of market expectations of near-term volatility conveyed by S&P 500-stock index option prices, has spiked over the past six trading sessions. The index's average closing price for 2007 through Feb. 26 was 10.79. In the six subsequent trading sessions, the index's average close has jumped to 17.23, conveying a significant increase in market volatility (see BusinessWeek.com, 3/8/07, "Stock Signals You Can Use").
Cautious on Retail Exposure
While we believe the exchanges as a group are benefiting from the recent market fluctuations, longer term we see those markets more exposed to institutional investors enjoying a greater benefit from increased uncertainty. In particular, we believe the Chicago Mercantile Exchange and CBOT Holdings' Chicago Board of Trade are well-positioned, given their broad product portfolios, which include exposure to equity, fixed-income, and commodity markets. We would also highlight the NYSE Group, owner of the New York Stock Exchange, as positioned to benefit from increased volatility through its pending acquisition of Euronext, a large European equities and derivatives exchange.
We are more cautious on those exchanges with greater exposure to retail investor trading, particularly the International Securities Exchange (ISE; ranked 2 STARS, sell) and the NASDAQ (NDAQ; ranked 3 STARS, hold). We believe prolonged volatility, particularly in a downtrending market, could have a negative impact on retail investor participation in the market.