Democratizing Index Options: A chat with Cboe CEO Fred Tomczyk

Yeah. So I've had a very clear career all through financial services. I was in banking, then insurance, back to banking, over to wealth management. And then I ran some corporate areas of a big bank, and then wound up at Ameritrade. So I've seen it from a variety of different angles, and I've seen people be afraid of options. I've seen people for a variety of reasons, but differently than you would have seen 30 years ago.

From my point of view, it's not about telling people what they can and cannot do in their investing. It should be trying to help them be better at what they do. And that's a big difference. And companies take different approaches to that. With respect to options, when I ran Ameritrade, I took over. I was in management as the chief operating officer and was essentially running the company for about a year before I took over, because we had some integration issues between the old GE Waterhouse and Ameritrade. But I took over on the eve of the Great Recession. So if you could imagine your first day on the job, you're landing the job and all of a sudden the world's blowing up.

It was just an equity trading shop and had consolidated the industry. But we saw this little company called thinkorswim that was actually growing quite nicely. And one of the things you learn in this business is that an equity trader in a down market will freeze and say, I don't know what to do, I'm just going to play it safe. Whereas a person who can trade options can trade through any environment. And in fact, that's what we do at Cboe is try to provide a suite of products, option based products that you can trade in any environment and take advantage of different markets. So when options came out, you always have this fear when you first get into it, but that's why you have to pivot into this thing called education, which we've been doing for 35 years.

The biggest change in financial services and mostly in this space is how much technology has changed everything. I can remember when you had to call a broker to place a trade, you might get a response 2 or 3 days later. And you probably paid $250 or $300 to place that trade. Whereas today you can basically go online, you can look at that stock, you can press a button and under a second it executes, and the price you got was zero commission. So it's amazing how much it's changed over time. And options basically give you a way, if you have a long portfolio, to enhance your income on it or to protect it when you're worried about it.

When I retired, five or ten years later, it was 45% of our trade volume when people started to learn how to use them and how to use them properly. So it's evolved quite a bit to today. It's one of those areas, the whole option industry, both institutional and retail, but in particular retail, is growing, and the adoption of options is growing not just in the U.S. but around the world.

Yeah, yeah. I would always advise you to start with the education to make sure you understand it and how to use them properly, because if you don't learn that, I guarantee you eventually you will blow up. So you have to start just like investing in equities or anything. You have to have a strategy or a methodology and stick to it.

And then once you get more comfortable, you can work up into spreads and find out some traits. And when you do that, then you start to get smart, and then you can be quite creative in what you do because you can do almost anything with options. There are so many expirations and strike prices. You can take a variety of strategies around your portfolio, but don't go there initially unless you really understand what you're doing. Take the education. It'll pay off for you.

Yeah. So I think it's important you understand the uniqueness of the index option. Index options typically provide you with broad based exposure or protection, but it's going to be off of an index like the S&P 500. So use the SPX as an example or XSP. You can also do small cap with the RUT 100.

Equity options are typically American style. And if you take the index options, they are going to be European style. What that means is they only exercise at the expiration, whereas an American style, somebody can call your trade away. So if it goes through and it's in the money, they want to take that stock or that index, they'll take it away from you. And if you're doing a multilayered trade, all of a sudden one of your legs is gone and you're exposed in a way you didn't know. So an index option, that European style, is important because it cannot get called away on you, and it's cash settled, whereas an American style is typically physically settled. I mean, you get the stock. So if you bought a call and it goes through, you exercise your right.

You put it on, you don't need to worry about it. It's going to expire in cash. So right into your account on that day. So that's a very great feature for most retail traders. It's why it's very popular with a lot of traders. And again, it gives you that broad based exposure. And even if you have a portfolio that is not far off the S&P 500, you can use these for hedge risk management or whatever. Because it won't give you the perfect hedge, but it'll give you a cushion. And then lastly, they get favorable tax treatment. So whenever you use a European style index option, it's 60% long term, 40% short term capital gains, regardless of how long you hold it. So it's one of the unique features.

Yeah. So I think the analogy I use is a bit of Apple, right? Whether you're an Apple fan or not, is how they've been able to make technology and interface with technology so simple and intuitive that even one of my grandchildren can figure that thing out.

I love the bars you had yesterday where you can just click on different prices you want to put your order in and all that kind of stuff. And just make it so simple, easy and fast. And you can think, well, that's simple. That's hard to do. Because behind there, there's a lot of stuff going on. But that's really what's happening with technology. Technology has changed so much of our lives, and no more so than investing and trading, where everything can be at your fingertips on our mobile device. But doing that is actually hard work. And I think Robinhood has done that very, very well. But I'm looking to the future.

And so I could see a world where, years from now, you could be trading computing power. If you just look at the world today, the race with AI, the chips, and how much the data centers are growing, computing power could become the new oil as an example. And it's becoming a bigger part of a company's income statement. And so you can see a world where you can see all kinds of new asset classes that people can trade in and invest in, and do that through that mobile device. And as Steve's right, when we both thinkorswim, I can tell you my board was like, are you sure you want to do this? It was because of me. Yeah, I'm like this guy.

We talk to our clients about what they're looking for. And we have the biggest institutional clients, the Citadels of the world, which are big market makers and big proprietary trading shops. And so they have ideas. So it's important to get out and talk to them. But also increasingly important is to go and talk to people like Robinhood and the retail brokers that are on the cutting edge of the thinking in this regard, leveraging technology, trying to create new things. And so you get that and you get ideas. And then when you come back, you start to think, okay, well, how can I trade something about that? And you're typically going to start with a product. So like the example we use all the time is the SPX on the S&P 500, which by the way is the largest. There's $16 trillion globally that you can trade through that instrument through a variety of ways such that you can trade through any environment. So we always think about creating an ecosystem to give investors and traders products that they can trade and optimize to hedge risk, generate income, or place a speculative bet. But to do that around that index using a variety of products and index products such that regardless if you're a retail client or an institutional client, we can give you the product that you're looking for, through any environment you can trade all the time. So I think it's one thing to trade in a bull market and you can think you get brilliant, but you really don't know what you're doing until you go through a bearish market.

Yeah. So I would even say today people get a bit freaked out about volatility because the VIX is up at 20. That's a long term historical average. The anomaly has been the last ten years, not the norm.

So we do see that. I mean, the global markets have capitalized. I think I start with a point of view. If you go to various countries around the world because we are a global exchange operator, everywhere I go, everybody would like us to do what we do in their market. So they get that we bring competition, bring options, etc. And so we definitely are doing that. We're doing that in Europe right now with something called Cboe Europe, which is bringing derivatives to the European market, which is a first.

There are $28 trillion of foreign holdings of U.S. securities, of fixed income and equities, about $14 trillion. That is the US equity markets. The US equity markets are larger than any other country's GDP in the world. So it's a very big, very deep, highly liquid market. And people want access to that. So that gets back into the 24/5. So if you're in Japan, you want to trade during the day, not necessarily in the middle of the night. And so we see this as an evolution where we call our import business is to give those people access to the US markets. And that means doing it around the clock and improving their experience.

We started up an operation in Singapore that did quite well, but they were mostly all we were giving them was access to the US market. They may want to trade in their own market, but if you went back and looked over the last five, ten, 15, 20, 30 years and you looked at the returns of various equity markets around the world, the one that stands out consistently as the best performing, and not by a little bit, by a lot, is the US market. Never underestimate the power of the US market and the demand for it. And there's a reason for that. If you go back and look at performance, the stability of the dollar, all that kind of stuff, it is a very powerful, what we call a long term secular trend. So I think it's a desire. I know my desire. And by the way, we all trade in the evening. A lot of people do their research, they do their homework, they look for their trade or investment thesis in the evening, because they might work during the day. And it's very foreign to them that they can't just put that trade in, pick the level and enter that trade. I think everybody's used to an e-commerce world. So in the old days they used to say, oh no, you need all these people standing on a trading floor. Well, Covid kind of disproved that. I think we didn't have anybody on the trading floor and it worked pretty fine. So it's my dream, and I'm going to lean on him to have more and more instruments that trade around the clock. I think everything should trade around the clock. I don't think it should ever close. It's an electronic exchange. Right. So yeah.

Yeah. Well, it's again part of our journey of innovating and just allowing people to trade through an environment. And we're in a world today, whether you like it or not, it's a news driven world. It's an event driven world. Just think how much people watch the market when you have a CPI print or the Fed releases their decision on interest rates. So you have these events that have really become things that rule the market. And Steve's right, basically. And what the short dated options allow you is a very efficient way to hedge risk or take advantage of an event in a very short period of time. Because the premium is so low, it's just a fantastic tool.

Okay. So we started doing Tuesdays and Thursdays and the product took off. And so then we did Mondays and Wednesdays. And so you go into this world where we just keep listening to your clients and recognize the world that you live in is changing. We've got two wars going on and we got an election coming up. We got the Fed pivoting. It's an event driven world. Whether you like it or not, we are. And what are called zero day options, several days to expiry, have been around for a long time because you can always trade that option one day, a quarter on that day. And so when you think about it, it's these simple little innovations. Just say, well, wait, why is it just that day? Why don't we make more expirations and allow people to get cheap insurance?

So it just gives you a very efficient way to sort of hedge risk around an event that you're worried about.