RPT-U.S. option volume slows from record pace

(Repeats to add dropped words, same period last year, to first paragraph)

By Doris Frankel

CHICAGO, Dec 1 (Reuters) - The options market suffered a setback as U.S. exchange-listed volume last month fell 21.2 percent to 224.9 million contracts down from 310.8 million contracts for the same period last year, the Option Industry Council (OIC) said on Monday.

The drop in November volume comes as annual overall option volume stood at record levels of 3.4 billion contracts, up 28 percent from the 11 month period in 2007.

Trading fell for several reasons. Last month had fewer trading days. This year, November had two trading days less than November 2007.

Hedge funds, which had made the U.S. options market their favorite hunting ground for several years, pulled back in overall trading activity as they deleveraged and contracted in the mortgage-inspired stock market downturn.

And heightened volatility reflected by this year's record rise in the options fear gauge, the so-called VIX, raised option premiums, making it more challenging for investors to manage their stock market risk.

"The options market was hit by a one-two punch in November," said Mark Longo, founder of Chicago-based Web information site www.TheOptionsInsider.com.

"With the price of portfolio insurance going through the roof, and the market swinging dramatically every day, many options investors decided that discretion was the better part of valor," Longo said. "When you also factor in a shorter trading month, it is not surprising that options volume declined dramatically in November."

Average daily volume for November was down 12.9 percent to 12.9 million contracts from 14.8 million contracts for the same period last year, according to the Options Clearing Corp, the world's largest derivatives clearing organization.

Equity options saw 223.3 million contracts change hands last month, 21.1 percent less than November 2007, the OCC said in a statement.

"Some investors, who were heavy participants of options, have pulled back their trading recently because of the economic situation," OIC spokesman Jim Binder said.

Trading activity in hedge funds decreased in September and October. The HFRI Fund Weighted Composite index, which tracks the performance of about 2,400 hedge funds, fell 6.1 percent in September and 6.3 percent in October, its worst back-to-back monthly declines since its inception in 1990, according to Hedge Fund Research Inc in Chicago.

"In October, hedge funds were forced to reduce their positions dramatically, including options," said Steve Clausen, chief investment strategist at online brokerage OptionsHouse, a subsidiary of options trading firm PEAK6 Investments LP in Chicago.

"So for the month of November, there were no real new buyers of options as these hedge funds had completed their forced selling," he said.

The Chicago Board Options Exchange Volatility Index .VIX also stayed at heightened levels last month.

The VIX, which tracks projected stock market volatility conveyed by near-term Standard & Poor's 500 index .SPX option prices, rose 2.4 percent from October to an average of 62.7 percent.

"Although volatility remains high with the average VIX at 62.7 percent, compared to 61.2 percent in October, we believe the sustained volatility has caused some traders to retreat from the market," said Sandler O'Neill analyst Richard Repetto in a note to clients. (Reporting by Doris Frankel)