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June 30, 2003

The Sudden Success of Program Trading: Does a new trend mean the demise of block trading?

By Gregory Bresiger

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Program trading on institutional desks has become popular at a time when markets are volatile and trading margins depressed.

"Program trading desks are a necessity these days," said Michael Mook, co-director of program trading at Weeden & Co. "At large firms, at bulge bracket firms, they all must have program desks."

Mook estimated that program trading accounts for 30 percent of the business of an average desk at a big sellside trading firm. In the late 1990s, he said it was about five percent.

Mook predicted that, in five years, program trading would cover about 45 percent of the institutional business. Big firms have no choice, trading executives stressed.

"This is a question of where necessity has become the mother of invention. We could have done this many years ago and saved a lot of money. But when we were in a bull market, no one wanted to challenge cultures at that time," said one trading executive, who didn't want to be quoted by name.


A 40 percent drop in most stock market indexes over three years will do a lot to change cultures in a hurry. So will unprecedented volatility. For example, back in the mid-1990s, the S&P 500 index could go some two years without rising or falling two percent in a single day.

Last year, that kind of thing happened at the S&P about once a week and on the Nasdaq about twice a week. That has taken program trading from an exotic strategy used by quant houses and tech nerds to the mainstream of the trading world.

Indeed, on a recent week on the New York Stock Exchange, some 10 percent of the program trades involved stock index arbitrage. Program trading overall accounted for an average of 487 million shares daily, or some 40 percent of the Big Board total.

Some of the largest growth in this program trading is from institutional investors buying and selling portfolios of stocks. This kind of institutional program business is called portfolio, or basket trading. And it is becoming big business.

But what exactly is program trading?

"Program trading," the Wall Street Journal states in a definition many trading executives endorse, "is the simultaneous purchase or sale of at least 15 different stocks with a total value of $1 million or more." The biggest players are Morgan Stanley, UBS, Goldman Sachs Group, RBC Dominion, Deutsche Bank Securities and Credit Suisse First Boston.

"Program trading is the trading of large numbers of stocks, large numbers of orders in some coordinated way at the behest of a client," said Larry Leibowitz, executive vice president of equities at Schwab Capital Markets. It began with index arbitrage and machine generated orders, but trading executives say its application has spread tremendously over the past decade.

"In addition to lowering costs, program trading has become an essential risk management tool," said Alan Rubenfeld, a director in Deutsche Bank's global portfolio trading group.

"For a firm to become an effective portfolio management player, it must have worldwide capabilities and offer both principal and agency options," added Sean McFarland, another director in this group.