NYSE, Nasdaq Stocks Gain from Heightened Volatility

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NYSE Euronext

Although it might seem a surprise for some, it is possible to trade the stocks of stock exchanges themselves. Both Nasdaq (NASDAQ:NDAQ) and NYSE Euronext (NYSE:NYX) trade on their own exchanges and coincidentally both stocks are similarly priced at around $25 per share and their trading volume averages at around 2.5 million. The Trefis price estimates for NYSE is ahead of the current market price at $33 and implies a stock valuation of around $8.7 billion. Nasdaq looks fairly valued at around $25 according to Trefis.

See Full Analysis for NYSE Euronext Here

Derivatives Trading to Drive Growth

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Trefis analysis expects a notable increase in trading volume, for which the exchanges receive a small commission. Derivative trading accounts for nearly 42% of both NYSE’s and Nasdaq’s Trefis price estimates, with nearly a third of Nasdaq’s value coming from U.S. derivatives trading. There are a few reasons to expect greater activity in these services as volatility and uncertainty hit markets and inspire both greater sell-offs and more speculative buying, as well as day traders following the moves of larger institutional holders. All of this greater activity means more commissions for the exchanges, which should boost their profitability and their stock prices.

Volatility and Trade Volume

The conventional wisdom about volatility is that it provides market inefficiencies that short-term traders can capitalize on. With a stock falling by two points on Monday, rising three points on Tuesday, and falling five points on Wednesday, there is a greater incentive to buy, sell, and buy again. Day traders rely on volatility, and the more volatile the market, the more money they can make. This past summer, the NYSE and Nasdaq saw violent volatility after S&P downgraded the United States’s credit rating after Congress played a game of chicken with the nation’s debt ceiling. The historically unprecedented move caused the Volatility S&P 500 Index (^VIX) to swing from 17.52 in mid-July to over 43 a month later.

Since greater volatility means greater trades, it was no surprise that the NYSE reported higher trade volumes both by comparing year-on-year and month-on-month, even after low trade volume in the previous month. [1] [2] The downgrade also contributed to, in the NYSE’s words, “new monthly trading records in U.S. equity options and European cash.”

Now the source of market uncertainty has moved from America’s debt rating to the European bond market, but volatility is still up. The VIX has stayed in the mid-thirties for the past two weeks.

Dark Pools

Loss of confidence has given another boon to the exchanges: dark pools, once popular with investors, are becoming less appealing as uncertainty has made even the most reliable investments relatively risky. Dark pools are where trades of stocks can be made off-exchange, which allows institutional investors to make large-scale trades without affecting the price of the stock. Recently, brokers such as Goldman Sachs (NYSE:GS) have gotten more deeply involved in dark pool trades, causing a serious threat to exchange volume, and thus the value of NYSE and Nasdaq. [3]

The risks associated with dark pools have made them less popular, and reports of investors fleeing the pools suggests that large-scale brokers and institutional investors are returning to the light of day exchanges. This can only help increase volumes, directly benefitting the exchanges. [4]

Optimistic Exchanges

Looking ahead, there is good reason to feel bullish about both NYSE and NASDAQ, especially after the New Year, when traders become more active and new year optimism sometimes drives aggressive investment strategies. Although trading volume is thin at the moment, this can change very quickly, as it did last summer.

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Notes:
  1. NYSE Euronext Announces Trading Volumes for August 2011, NYSE Press Release []
  2. Where’s the volume? Stock trading quiet in July, AP []
  3. SEC puts the light on dark pools, CNN []
  4. Investors Flee Dark Pools, WSJ []