HFTs Struggle With Options
Traders Magazine Online News, December 19, 2011
High-frequency trading may have transformed the country's stock exchanges into ultra-fast, high-volume marketplaces, but it has had little impact on U.S. options exchanges. Five years into the penny tick/maker-taker revolution, high-frequency traders are bit players at best in options.
The four maker-taker exchanges, those most attractive to speedy, high-volume shops, control only about 20 percent of industry equity volume, barely more than they did five years ago. Two of them even took steps last year to better accommodate market makers, whom they previously treated no differently from any other trader. Both Nasdaq Options Market and BATS Options began offering bulk-quoting technology to traditional dealers in a bid to attract more liquidity. In equities, most liquidity is provided by HFTs.
The dearth of HFTs in options has largely been attributed to market structure barriers. That includes rules that maintain market-maker privileges, keep professional traders at bay and keep exchanges slower than they might otherwise be. While the marketplace is dealer-centric, some high-frequency traders say the biggest problem is actually the product itself. The instrument involves too much risk, offers too few price points and can lack liquidity.
"The only strategy you can run in high-frequency trading is market making," Peter van Kleef, chief executive officer of Lakeview Arbitrage, said at a recent industry conference. "Because once you go beyond the in-the-money strike, spreads widen out. So you can't just keep lifting the offer and hitting the bid. The spread will just eat you up."
HFT strategies are varied, but perhaps the most popular-at least in equities-are market making, arbitrage and momentum. HFT market making typically centers on highly liquid instruments with big volume and thin spreads. In options, that involves contracts in near-term months and with strike prices that are close to the price of the underlying stock. Most options market makers are not high-frequency traders, although proprietary trading house Getco has moved into the market in recent years.
While moving in and out of highly liquid options contracts may be no different from trading highly liquid stocks, other forms of high-frequency trading are more problematic, especially for the small hedge funds that dominate the field.
"When you trade options, you're trading volatility," Mark Holt, head of systematic implementation at BlueCrest Capital Management, said at a recent industry conference. "Thus, it's a lot more risky for high-frequency traders."
British hedge fund BlueCrest, Holt said, trades heavily in futures, less so in options. That's not surprising, as most high-frequency trading of exchange-listed derivatives is in futures. According to a report issued by the Aite Group in 2010, about 25 percent of global futures volume is done by HFTs. The research house expects that figure to rise to 40 percent by 2015, noting that the industry is far ahead of the options exchanges when it comes to electronic trading.
At this year's High Frequency Trading World conference, held in New York, Holt explained that most high-frequency traders are small and undercapitalized. That makes the firms think twice about taking positions in options as opposed to stocks. "Your full risk is far less predictable than just trading on pure price," Holt said. "It's a far more complex marketplace. You're not just taking that single price and making the best of it."
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