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June 2, 2009

Two Birds, One Stone

Latest algorithms trade in two or more asset classes simultaneously

By James Ramage

Kill two birds with one stone. That's the pitch from some of the industry's top suppliers of algorithms to those looking to trade more than one asset class simultaneously. In a relatively new development, a handful of major brokers have developed algorithms that let traders quickly lock in prices in order to hedge positions or conduct arbitrage trades across markets.

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"We're seeing a combination of client types showing interest in cross-asset strategies," said Owain Self, who heads algorithmic trading at UBS for the Americas, as well as emerging markets and Europe. "Cross-asset strategies, and the advanced technology that makes them possible, facilitate efficiency and growth."

UBS is one of several brokers, including Goldman Sachs and Credit Suisse, developing these algos. The ability to trade two different asset classes against one another in a single transaction, or strategy, using algorithms gained momentum last year as brokers either developed or released cross-asset algos.

The practice of trading a stock and a derivative at the same time is known as cross-asset trading. On the options side, in the U.S., trading cross-asset has been around for almost 140 years on an over-the-counter basis. On the futures side, portfolio managers have been able to manage their risks with index products since 1982.

The need to trade across markets has always been there, but the process has never been the most efficient. Traders want to get the job done as quickly as possible to lock in prices. Sometimes that happens. Sometimes it doesn't.

In Times Past

Up until brokers developed these algos, a trader had to access each marketplace separately. And the buyside started doing this through sales traders.

The buyside would pick up the phone, give instructions and pay a fee, according to Andy Nybo, principal and head of derivatives, TABB Group. The sales trader, in turn, would contact the cash equities desk, the futures desk, the options desk or the foreign exchange desk-whichever desks were handling the legs of the trade. But it can be more than three times as expensive to trade a futures contract over the phone than to trade it electronically.

Cross-asset trading via direct-market-access platforms started to take root earlier in the decade. This sped up the execution process for the buyside.

But some say DMA can be cumbersome. It can be awkward trying to lock in both legs of the trades.

Recent advances in electronic trading have taken much of the legwork out of more complex trades. The technology to trade more than one asset class on a single platform has evolved and made it easier for traders to develop more advanced cross-asset strategies, according to Harrell Smith, head of EMS maker Portware's product strategy group.

Algorithms themselves are well established. And the benefits of algorithmic trading this decade have been faster and cheaper trades.

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