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Of pits and puts: the case for options algos

Published in Automated Trader Magazine Issue 30 Q3 2013

Eva Szalay examines prospects for execution algos in the complex, liquidity-strapped options world.

With about a quarter of options now executed electronically in the US, European markets are expected to increasingly move to screens in the coming years. But challenges in both markets remain as pit traders still rule execution in complex contracts.

In the US, there are 11 exchanges to execute options on equities, while new products on treasury options launched by CME Group have exploded in terms of volumes in recent years. Late last year, electronic options trading on treasury options at the CME outstripped pit traded options for the first time. Since 2009, the share of screen-traded options has nearly quadrupled.

The change is driven by buy-side firms with sophisticated technology. In a survey of buy-side options research, Tabb Group found that some 58% of hedge funds now incorporate one-week expiry options into their portfolios. One-week contracts can be traded on the Intercontinental Securities Exchange and the US options trading arms of BATS and NYSE Euronext.

In the US, there are companies offering algorithms for executing even complex, multi-leg contracts.

Hazem Dawani, CEO and founder of Options City, describes his company's software as pioneering in the effort to make complex strategies such as butterflies and condors easier to trade. "(The software is) helping a lot of traders to quickly price them, RFQ them and trade them electronically. This has had a role in assisting the transition of these options products to the screen," he says.

The most advanced market is options for equities, where the US has seen double-digit growth accompanied by declining cash equities volumes. One reason for the push is that, like currency markets, options markets fared relatively well in the height of market stress and volatility in 2007 and 2008.

Greenwich Associates, a US-based consultancy, pointed out that in Europe shifts are coming, but the extent of fragmentation across markets could slow the process significantly. The consultancy highlights in a report structural features such as currency and country fragmentation issues, and illiquidity in small -and mid-cap stocks within national markets as the main hurdles to overcome.

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