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Cancelled IOC orders reveal information about potential liquidity in options market

Published in Automated Trader Magazine Issue 37 Summer 2015

Deutsche Borse's new analytic, the 'Eurex IOC Liquidity Indicator for Options' creates potential for improved price discovery and offers new signalling opportunities.

Making the invisible visible

If an exchange's order book were a cash register in a shop, it would show transactions at the counter, but not customers who came into the store wanting to buy something but then left without doing so. At least this is the case when it comes to 'immediate or cancel' orders (IOCs). Those lost opportunities for transactions - not filled immediate or cancel orders - are not recorded in the order book, yet represent real potential liquidity. Deutsche Börse Market Data + Services has launched a new product within its real-time analytics product family that allows traders to gauge those potential transactions in the options market and trade accordingly, resulting in fewer 'empty shopping baskets'.

IOC Liquidity Indicator

Mechanics of the IOC Liquidity Indicator

Observing the transaction information displayed in an order book provides details of successful transactions but does not indicate the depth of book by potential fills. As IOCs that are not executed simply disappear, market participants typically have no information about other IOCs that could have been interacted with.

Deutsche Börse's IOC Liquidity Indicator is based on an analytical engine that sits on top of the exchange's internal real-time market data streams. This engine extracts the relevant non-public information and aggregates it according to a published algorithm in the form of the IOC Liquidity Indicator. Specifically, the Eurex IOC Liquidity Indicator for Options provides traders with the aggregated volume of cancelled IOC orders that did not match within a defined time period and the details of the order execution that prevented the remaining IOCs from being filled. In doing so, it gives users information on liquidity for orders at the market price, potentially improving market quality. The indicator is calculated for more than 70 Eurex options, including options on Euro-Bobl futures, Euro-Bund futures, Euro-Schatz futures, DAX options and EURO STOXX 50 options.

Unlocking potential alpha gains across strategies

The IOC Indicator helps to unlock potential alpha gains across multiple strategies. For example, a market maker who observes that a lot of IOCs are being cancelled, could increase their throughput by adjusting their bid/ask spread so it reflects those orders. An algo trader wishing to deal in certain options can get an indication on the true liquidity of an option and can use the indicator to adjust the frequency of their orders.A trader can also use the IOC Indicator to gauge the potential size of trades, even for less liquid options, by observing the amount of surplus liquidity in the game after an order has been filled. They could then increase their trade size accordingly.

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