Effects of the Covid‐19 pandemic on derivatives markets: Evidence from global futures and options exchanges

• Published date: 01 May 2022
• Author: Ekaterina E. Emm,Gerald D. Gay,Han Ma,Honglin Ren
• Date: 01 May 2022
• DOI: http://doi.org/10.1002/fut.22310

Received: 19 August 2021

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Accepted: 30 December 2021

DOI: 10.1002/fut.22310

RESEARCH ARTICLE

Effects of the Covid‐19 pandemic on derivatives markets:

Evidence from global futures and options exchanges

Ekaterina E. Emm

1

|Gerald D. Gay

2

|Han Ma

3

|Honglin Ren

4

1

Department of Finance, Albers School of

Business and Economics, Seattle

University, Seattle, Washington, USA

2

Department of Finance, Robinson

College of Business, Georgia State

University, Atlanta, Georgia, USA

3

School of Finance, Shanghai University

of Finance and Economics, Shanghai,

China

4

Department of Finance, School of

Business, Renmin University of China,

Beijing, Haidian District, China

Correspondence

Honglin Ren, Department of Finance,

School of Business, Renmin University of

China, Mingde Business Bldg, No. 59,

Zhongguancun St., Haidian District,

Beijing 100872, China.

Email: renhonglin@rmbs.ruc.edu.cn

Abstract

We examine key developments in trade‐related activity on global deriva-

tives markets during the Covid‐19 pandemic. We first document significant

increases in volumes and open interest. Drawing upon techniques from

network theory, we next find greater market interconnectedness and

notable changes in market centrality. For US exchanges, we examine their

response to the increased market uncertainty and find large and more

frequent changes to margin requirements. We also find a considerable drop

in trader participation driven mainly by noncommercial traders along with

an increase in the percent of open interest held by commercial shorts and

noncommercial longs.

KEYWORDS

Covid‐19, derivatives, financial crisis, futures, networks, open interest, options, volume

JEL CLASSIFICATION

G12, G13, G14, G15, G23, L14

1|INTRODUCTION

The outbreak of coronavirus disease (Covid‐19) and the subsequent spread of the pandemic have had tremendous

spillover effects on the macroeconomy and global gross domestic product (GDP) as governments, firms and individuals

dealt with the effects of lockdowns, social distancing, disruptions to supply chains, unemployment, and general overall

economic upheaval. As discussed in Baker et al. (2020), unlike other pandemics during the past hundred years, the

Covid pandemic led to unprecedented effects on the US stock market.

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In this paper we study various economic effects

of the pandemic in the context of an important component of the global financial system—derivatives markets for

exchange‐listed futures and options—for managing market risks and facilitating price discovery.

Our paper also seeks to provide a unique and natural extension of studies on the behavior and connectedness

of global financial markets during times of financial crises. The existing literature on market integration and

contagion has for the most part focused on equity markets and to a lesser extent on bonds and currencies, and on

how shocks to financial markets affect the valuations and returns of these financial assets. Our study focuses

on derivatives markets and sheds new light on how participants respond during times of heightened market

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Consistent with this, we find the increase in market volatility to be comparable to or exceed, in terms of its magnitude and speed of onset, that

observed during the Great Recession wherein the volatility index (VIX) experienced more than a 400% increase (from 18.5% to 80.1%) during the

eight and half‐week period of August 22–October 27, 2008. In comparison, the VIX index during the onset of the Covid pandemic increased more

than 500% (from 14.5% to 80.6%) during the much shorter 4‐week period of February 20–March 19, 2020.

uncertainty in terms of their trading activities and the role of exchanges in the process. In addition, we provide

new evidence on how levels of connectedness and financial integration of global derivatives markets are affected

during such times. Further, we focus on changes in trade activity rather than valuations or rates of returns as

examined in the existing literature on equities for two reasons: first, derivative instruments are not part of the

market portfolio as they are in net‐zero supply (i.e., the number of long positions equals that of shorts), and the

initial value of a derivatives contract is typically zero for linear derivatives, such as futures and swaps, or is small

for nonlinear derivatives, such as options. Additionally, to establish a rationale for studying volumes, we expect at

least three potential channels through which a volatility shock can induce trade activity in derivatives markets.

First, an increase in volatility could alter the demand for hedging and the need to manage the higher risks and

hence lead to greater trade volume. Second, an increase in market volatility could increase incentives and rewards

for speculators to gather private information to exploit and profit from trade and hence again lead to higher

volume. Third, if asset correlations increase during a market crisis, the presence of natural hedges can decline

leading to a greater demand for real hedging as a substitution effect and hence greater volume.

Our analysis is facilitated in part by a unique and comprehensive database containing trade volume and open

interest information for nearly all futures and options contracts listed on derivatives exchanges across the globe. The

data include information from 113 different exchanges in 40 countries spanning multiple geographic regions, including

North America, Europe, Asia, and Latin America. Further, the contracts cover those based on (1) financial instruments,

including bonds and interest rates, equities, and currencies; and (2) commodity products, including agriculture, energy,

precious and nonprecious metals, and other related items (e.g., weather, housing, and inflation). To explore more

microlevel effects of the pandemic, for a number of US‐based futures exchanges for which data are available, we also

obtain information on daily margin requirements (performance bonds) for a broad set of futures spanning multiple

asset classes; regulatory‐reported position information of commercial and noncommercial large traders; and amounts

of traders' funds held in accounts at all US futures commission merchants (FCMs) to support margin requirements for

their trading activities.

To help motivate our research questions as well as to place into historical perspective derivatives trading during the

pandemic in relation to that during prior financial crises, we present three related illustrations. Figure 1a shows the

time‐series of global monthly volume of futures and options traded over the period 2002–2021. On the basis of casual

observation, one can see large changes in early 2020 coinciding with the timing of the outbreak, and whose magnitudes

appear to exceed those during earlier notable periods of economic unrest, including the Great Recession (2007–2009),

the European debt crisis (2010–2012), and the Brexit referendum (2016–2017). These observations raise questions as to

whether they extend similarly across various geographic regions, derivatives product groups and asset classes as well

as, more broadly, to how financial market connectedness changed during the pandemic in the context of derivatives

activity.

Second, in consideration of the vital role of margins in protecting the financial integrity and solvency of FCMs,

exchanges and clearing houses, especially during periods of market crises, we similarly present in Figure 1b for the

period 2002–2021 the monthly time‐series of the total amounts of funds of institutional, corporate, and retail traders

held in accounts at FCMs to support the margin requirements for their trading positions. Of note, we observe a

historically large jump in such funds in March 2020 far exceeding that in any prior month.

Third, we present in Figure 1c the number of traders holding reportable positions in a large cross‐section of

contracts listed on US futures exchanges as indicated in weekly commodity futures trading commission (CFTC)

Commitments of Traders (COT) reports over the 2019–2021 period. Coinciding with the above‐noted record increase in

funds held in margin accounts in March 2020, there is a large decline in trader numbers followed by an upward trend,

thus raising questions about potential changes in the composition of market participants.

To investigate these observations in greater depth, we explore the following research questions that focus on four

primary areas of inquiry:

(1) What effects has the Covid‐19 pandemic had on derivatives trading activity on exchanges across major geographic

regions, including North America, Asia, Europe, and Latin America? Similarly, how have these effects varied

across different asset classes and derivatives instruments?

(2) How did the onset of the pandemic affect levels of connectivity in derivatives trading activity between countries

and geographic regions?

(3) In light of changes in market volatility, how did US futures exchanges respond in terms of adjusting margin

requirements to maintain financial integrity and protect against customer default? Further, what was the effect on

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