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SAP Closeout

Published in Automated Trader Magazine Issue 14 Q3 2009

Matt Hergest, Head of Liquidity Strategies at Instinet Europe illustrates the use  of a multi venue algorithm that accesses the primary exchanges, MTFs and dark pools to sell a position in SAP.

The Scenario: It is early June, and a major European fund manager is looking to complete the disposal of a holding in SAP. The core of this holding was acquired in late December 2008, with an additional position bought in early March 2009. Average price paid for the entire holding of 1,279,815 shares was €24.67. The bulk of the position (977,467 shares) has already been disposed of at (or near) two recent SAP market peaks on April 27th and May 19th for an average sale price of €30.68.
Recent weeks have seen a trickle of positive news on SAP. E.ON US has gone live on SAP and SAP's Best-Run Now packages have garnered positive press coverage on their successful use by major clients such as Coca Cola. In addition, Geraldine McBride, president of SAP Asia Pacific Japan, has recently appeared on CNBC to state that she believes that market conditions in Asia may have bottomed and that she sees the "green shoots" of economic growth.
This backdrop has driven another rally in SAP, which is currently approaching its April and May highs. Despite the good news, the fund manager regards this rally as the perfect opportunity to quickly complete the position close-out.
She regards the recent series of SAP rallies as a case of "a rising tide floats all boats", particularly in view of the stock's recent performance against the Dax index. After a strong start to the year versus the index through to early March (green ellipse in Figure 1), the stock has been a weak relative performer (red rectangle in Figure 1). (Figure 1 shows the difference in daily percentage returns between the Dax index and SAP.)
This relative weakness is of particular concern, as the Dax is currently approaching its high of the year (set in early January) and the manager feels the current rally is unlikely to be sustained much beyond that level. (Figure 2 shows a daily chart of the Dax index with the current high of the year highlighted in green.)
Therefore the manager decides that the remaining 302,348 shares of the position should be unloaded in the next trading session at a minimum target price of €30.80.
The Asset: SAP. Bid ask spread typically fluctuates around €0.02-0.03 (Xetra) and average daily volume (ADV) is approximately 4m.
The Challenge: To sell 302,348 of SAP during the next trading session, at an average price of €30.80 or better.
The Algo: A volume participation algorithm with a participation rate that can be varied on the basis of momentum (participate at a higher rate when price moves against the trader's benchmark) or value (participate at a lower rate when price moves against the benchmark). The algorithm offers three choices of execution style: Aggressive, Normal and Passive, which are based upon the extent to which the algorithm will allow participation to fall behind the target before attempting to catch up.
The algo has access to a smart order router, which uses a sophisticated price sensitive routing algorithm to help achieve the best price on marketable orders by systematically scanning exchanges, MTFs and dark pools - including primary exchanges, Chi-X, Chi-Delta, Turquoise (Lit and Dark), BATS, NASDAQ OMX Europe (Lit and Dark), NYSE Arca Europe and BlockMatch. In addition, the algo has options to place the balance of the order, in excess of the regular strategy, to dark liquidity venues including BlockMatch and third party MTFs and broker pools using dark-pool aggregation logic.
The Trader: The trader, who is based in Europe (all times below in Central European Time), handles large cap trades for the fund manager and uses a combination of cycle-weighted relative strength index (RSI) and a proprietary signal-to-noise ratio based on a Hilbert transform to assist him in timing major changes to execution algorithm parameters.

8.30am: The previous trading session on the primary market saw SAP close down on the day after a gap up opening. The company's outgoing co-CEO Henning Kagermann had given a mildly pessimistic newspaper interview stating that any current improvement in the economy was being driven by inventory re-stocking rather than real demand. That aside, there is no significant news overhang coming into the new session. However, a variety of commentators are calling the parent index higher on the back of gradually firming commodity prices.

The trader works on the assumption that the market will gap up on the open, possibly above his target price; he therefore opts to use the algo's value trading style so as to increase participation if the stock moves as predicted in his favour. He sets the target participation rate to 15%, the execution style to Normal, places 100% balance in dark as he is willing to seek out hidden liquidity and the limit price to €30.75.

Figure 1

Figure 1
Source: CQG, inc. © 2009. All rights reserved worldwide. www.cqg.com

8.50am: The algorithm starts to participate in the Xetra opening auction and by the time continuous trading begins it has disposed of 15,641 shares at an average price of €30.76.

9.00am: SAP gaps up as expected, opening exactly on the trader's limit price and almost immediately moving higher.

9.04am: The market is continuing to rally and the algo has managed to unload 35,416 shares across a mixture of lit and dark venues at an average price of €30.78.

Figure 2

Figure 2
Source: CQG, inc. © 2009. All rights reserved worldwide. www.cqg.com

9.07am: There appears to be at least one substantial buyer present in the market and SAP continues to rise, further disposals in the dark: 7,297. Similar success on MTFs and the primary market since the open, with the algo unloading randomised order slices of around twelve hundred shares and so far achieving sales of 22,257 mainly across Xetra and Chi-X.

9.27am: After moving steadily up for much of the preceding ten minutes to 31.09 on Xetra, the market has come off a little in the last few minutes and is now hovering near 31.00. However, the algo has continued to perform well, with a total of 23,689 across Chi-X, Xetra and Dark Venues in the past twenty minutes.

9.35am: Another reasonable rally backed by further strong activity from SAP buyers, which has pushed the stock to around 31.18. The algo has so far disposed of a total of 134,803 shares.

9.46am: The algo appears to have taken out the major buyer(s) and the disposal rate has slowed significantly. Total SAP sold so far: 153,878. Concerned that the market may be about to turn, the trader ups the execution style setting to Aggressive.

Figure 3

Figure 3
Source: CQG, inc. © 2009. All rights reserved worldwide. www.cqg.com

9.52am: SAP softening back towards 31.00. The switch to Aggressive has had a positive effect on Xetra and the MTFs, but dark activity has largely dried up. Total disposals so far: 168,303.

9.53am: Quick reversal in the primary market with the price on Xetra moving back up to 31.13. Most activity still on Xetra and the MTFs - total disposals so far: 178,804.

10.08am: Primary market activity now gappy and SAP now down to 31.00. Apart from one dark trade, all activity on Xetra and MTFs - total disposals so far: 183,488.

10.20am: Definitive weakness; the cycle-weighted RSI has given a sell signal by dropping out of overbought territory and the signal-to-noise ratio (SNR) has continued to rise, validating the RSI (see red rectangle highlight in Figure 3). With the trade little more than half complete and the Xetra quote at 30.93, there is a real concern that the market will quickly move below the limit price. In response, the trader switches the trading style to Momentum but leaves the execution style at Aggressive - total disposals so far: 186,682.

10.44am: SAP has continued to decline and has briefly dipped below the target price on Xetra. The switch to the Momentum trading style has improved Xetra and MTF sales as the market falls, but dark pool activity is currently minimal - total disposals so far: 197,190.

11.44am: Apart from one anaemic rally, the market has largely traded sideways for the past hour. Dark pool activity still very limited but some progress on lit venues - total disposals so far: 204,448.

11.53am: SAP now trading below the trader's limit price on Xetra. No activity.

12.59pm: Xetra intraday auction about to start, but SAP is currently quoted on Xetra at 30.57. The trader considers temporarily removing the limit price on the algo in the hope of substantial disposals during the auction, but opts for no participation.

1.59pm: Passing on the intraday auction is not looking like a great decision. SAP still way below the limit price at 30.57. Xetra/MTF activity is currently very thin.

2.00pm: One potentially positive sign. The cycle-weighted RSI has given a positive signal by lifting out of oversold territory accompanied by a (small) increase in the signal-to-noise ratio (see red rectangular highlight in Figure 4). Even though the SAP quote on Xetra is still well below the trader's limit price, he opts to switch the trading style back to Value as a pre-emptive measure, but moves the execution style back to Normal.

3.00pm: No activity for the past two hours, but a recent trade on Xetra has just touched the trader's limit price.

Figure 4

Figure 4
Source: CQG, inc. © 2009. All rights reserved worldwide. www.cqg.com

3.15pm: Sporadic trading during the past quarter of an hour above the limit price. Minor activity on Xetra/MTFs and one dark trade - total disposals so far: 207,217.

3.28pm: SAP has drifted back below the limit price, but the cycle-weighted RSI is still firmly in overbought territory, albeit accompanied by a falling SNR.

3.36pm: Signs of life on both lit and unlit venues - total disposals so far: 211,989.

4.03pm: After a brief flurry up to around 30.85, the stock has slipped back to touch the limit price and the algo's participation rate has dropped back in line with its current Value setting. Cycle-weighted RSI still overbought - total disposals so far: 223,402.

Figure 5

Figure 5
Source: CQG, inc. © 2009. All rights reserved worldwide. www.cqg.com

4.28pm: The stock has moved up to just shy of 30.90. Participation has increased with a dark block fill, while Xetra and all MTFs are now reasonably active - total disposals so far: 242,222.

4.48pm: Yet another pullback and reduced activity - total disposals so far: 265,458. With time running out, the trader shifts the execution style to Aggressive in an attempt to complete before the close.

5.28pm: After moving above 30.95 on Xetra, SAP has slipped back into the close to around the trader's target price. Fortunately, the switch to the Aggressive execution style has seen high sales rates on Xetra and Chi-X in particular and the Xetra closing auction was also effective. As a result, the order completes with two minutes to spare at an average sale price of €30.896. See Figure 5 for the volume curve of the trade (please note the irregular time intervals).

Note: This scenario is for illustrative purposes only.
There is no guarantee that the volume participation algo would perform exactly in the way described above.