The evolution of electronic trading in options appears to be following the arc taken in equities more than a decade ago, namely the use of electronic trading for execution of smaller-sized trades and floor-based trading for institution-sized orders.
In general, electronic trading has increased dramatically at Chicago Board Options Exchange since the advent and maturation of its hybrid trading model. In multi-listed equity and ETF options, most recently 90.5% of CBOE volume and 99.7% of transactions are executed electronically. In its flagship CBOE Volatility Index (VIX) and S&P 500 Index (SPX) End-of-Week options, 52.1% of the volume and 94.4% of the transactions are executed electronically.
“In the more institutional products, a significant share of volume continues to transact in open outcry where customers can gain market information from brokers and execute larger orders at a single price, while the speed and efficiency of electronic executions provides a convenient arena for more simplified transactions as well as electronic algos,” Anthony Montesano, CBOE vice president of business development, told Markets Media.
However, unlike in equities, where high-frequency trading-- and its attendant emphasis on co-location and latency—has changed the nature of market making, options trading does not lend itself well to the HFT model.
In options, raw computing power is applied to competing on quotes, rather than competing on how close one can put place an algorithm box to the exchange (though that does help for option execution), Derek Wang, CEO of Bell Curve Capital, said in a 2013 blog post. “Option exchanges do not see a multiplication of complex order types, as it happened in the equity market,” he said. “In other words, option market structure remains relative simple and rational.”
Montesano said that CBOE generally does not provide order types that simulate algos, “but rather accepts orders from users who have access to algos which generate individual simple or multi-leg orders to the various exchanges.”
Bell Curve Capital, an active user of advanced option algorithm executions, has developed a proprietary trading model for trading volatility. The firm has combined years of system development and quantitative research with direct trading and risk management expertise to achieve superior risk-adjusted returns with low correlation to the global equity market, according to Wang.
“The traditional way of executing a volatility trade is difficult because volatility is not directly tradable in the marketplace,” Wang told Markets Media in a June 11 interview. “It has relatively sophisticated execution requirements. In the past several years, major brokers have developed algorithms that allow these trades to be executed in a very precise way. We have been one of the forerunners in taking up these algo to execute our trades. It has been quite successful in the last two or three years.”
Given the characteristics of options and the relationships between the various strikes and expirations, options provide a good opportunity and fit for certain electronic strategies, said Montesano. “Those strategies we are aware of differ from those used in HFT,” he said.
Some strategies utilize smart routing to obtain the best price(s) across the 12 U.S. options exchanges, Montesano said. Others “leg” the various components of a complex or multi-leg order in an attempt to obtain the best overall price. Still others allow a user to enter an order in volatility terms, which would generate many individual orders across multiple option series and are automatically re-priced as the underlying moves.
Featured image via treenabeena/Dollar Photo Club