In a post-Brexit world, buy- and sell-side traders are relying more on new technology to execute orders based on volatility and not absolute price.
In an interview with Markets Media, Troy Googins, director, institutional sales at Wolverine Execution Services in Chicago, discussed how recent geopolitical events have boosted volatility and made it more difficult for options traders to best execute orders. According to Googins, after an initial Brexit-induced spike in volatility, which has since subsided somewhat, traders have continued to deploy technology to manage options orders.
“WEX saw a steady increase in volatility trading via our Vega Trader applet leading into the Brexit vote and a spike in usage after the vote as those volatility traders reacted to the results,” Googins said. “And traders are continuing to trade options as a means of buying and selling volatility as well as hedging positions, relying more on software such as WEX’s Vega Trader to assist in this volatility trade.”
Vega Trader is a trading applet that allows either buy- or sell-side traders to provide trade inputs to specify a target amount of vega to execute across a range of option expirations and strikes.
Vega is the measurement of an option’s sensitivity to changes in the volatility of the underlying asset and represents the amount that an option contract’s price changes in reaction to a 1% change in the volatility of the underlying asset. Vega changes when there are large price movements (increased volatility) in the underlying asset, and falls as the option approaches expiration.
Googins said that in June, including after the June 23 Brexit vote, usage of Vega Trader was up nearly 40% over May. This is more than double the volume for the software usage from the first couple of months of this year. Furthermore, volatility trading has continued to remain popular with traders as the usage rate of Vega Trader has increased another 25% in July (to date) compared to June.
And the usage of Vega Trader is evenly split between the buy- and sell-side, he added. Traditional institutional investors are using the system to help buy and sell volatility expectations while the sell-side, mostly banks, are using the system to manage risk and/or hedge positions.
Vega Trader works an order in three distinct ways:
Join – It places option orders to buy at the bid or sell at the ask when specified market conditions are met. Orders are designed to only post liquidity. Users can also elect to only join markets until an opportunity to remove liquidity presents itself, at which point the market is swept prior to the order returning to a passive joining only mode.
Post – The initial order will be placed at the most aggressive price allowable without violating the desired volatility limit. This may, or may not, result in the initial order taking liquidity or improving the current market.
Take – An order is only placed when the desired limit is currently achievable in the marketplace. It will only take liquidity which allows a trader to hide the size of the order.
“The simplicity of Vega Trader allows user to load up to 40 different expiration dates and strikes in a given security and to see which strikes help them achieve their target Vega,” Googins said. “It can even automatically hedge a position for a trader – either by using the underlying stock security or a future.”
Vega Trader also lets traders select custom order routing and type usage, including using WEX’s Sweep-X for options and WEX Best-X for equity hedging. Lastly, it can automatically limit the exposure on any one strike by setting a maximum amount of Vega per strike.
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