Municipal Use of Options
Options became exchange listed in the 1970's when the Chicago Board of Options Exchange and other regional exchanges began listing exchange traded option contracts. A large portion of the state and municipal pension statutes were in place prior to the creation of the centralized exchanges and, as a result, we believe, options were excluded as permissible investments by virtue of not being standardized prior to pension ordinances being enacted.
In recent years, a number of states have adopted more relaxed pension investment guidelines at the state level. However, statutes allowing the use of options have not fully trickled down to the local law levels. Looking nationally at the public pension space, you see that the use of options by municipalities is predominantly on the West Coast. Nationwide, municipalities are not unfamiliar with the use of derivatives as many City Treasuries (also, Police and Fire) hedge commodity costs such as, gas, water, or energy, or enter into interest rate hedges when issuing municipal bonds. Just looking at the balance sheet of a City may show that the City Treasury has commodity hedges and interest rate hedges on municipal bonds in excess of the market value of the pension funds. It's likely that a number of pension plans would consider de-risking their portfolios if they were aware of their City's use of derivatives to hedge risk and that their states may have relaxed pension statutes to accommodate the use of options for de-risking.
Options became exchange listed in the 1970's when the Chicago Board of Options Exchange and other regional exchanges began listing exchange traded option contracts. A large portion of the state and municipal pension statutes were in place prior to the creation of the centralized exchanges and, as a result, we believe, options were excluded as permissible investments by virtue of not being standardized prior to pension ordinances being enacted.
In recent years, a number of states have adopted more relaxed pension investment guidelines at the state level. However, statutes allowing the use of options have not fully trickled down to the local law levels. Looking nationally at the public pension space, you see that the use of options by municipalities is predominantly on the West Coast. Nationwide, municipalities are not unfamiliar with the use of derivatives as many City Treasuries (also, Police and Fire) hedge commodity costs such as, gas, water, or energy, or enter into interest rate hedges when issuing municipal bonds. Just looking at the balance sheet of a City may show that the City Treasury has commodity hedges and interest rate hedges on municipal bonds in excess of the market value of the pension funds. It's likely that a number of pension plans would consider de-risking their portfolios if they were aware of their City's use of derivatives to hedge risk and that their states may have relaxed pension statutes to accommodate the use of options for de-risking.