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June 1, 2010

Slow Uptake for Options Algos

By Peter Chapman

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  • Slow Uptake for Options Algos
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It's a tough slog for brokers championing the electronic trading of options.

According to a panel of experts assembled at this year's Options Industry Conference, the options industry is five to 10 years behind the cash equities business when it comes to servicing block orders with algorithms. While the big brokers are managing to cope with the rapidly changing market structure, they face roadblocks when it comes to broadening the appeal of electronic trading to their buyside customers.

"Our industry is in its infancy," Calin Ciordas, a director at Credit Suisse, told the OIC crowd. "Only a handful of firms have implemented time-based algorithms, and I don't think the clients have expressed much interest."

Time-based algorithms are those that slice up large orders and feed them into the marketplace over the course of some time period. They account for about 70 percent of all trading in cash equities, but very little of options trading. That's not to say algorithms aren't used in the options industry at all. Market makers use algorithms to price their merchandize and brokers have devised one-off order-like algorithms. But the algo revolution that swept institutional block trading in equities has yet to arrive in the options industry.

The catalyst for the revolution in cash equities, of course, was decimalization. Penny ticks caused spreads to collapse and size at the inside to diminish. That made trading orders in blocks impossible and ushered in the era of slice-and-dice algos.

With the four-year-old penny "pilot," the options industry is moving in the same direction but slowly. Spreads have shrunk, but liquidity is still available from market makers in size. Voice brokerage predominates.

There are other obstacles to institutional acceptance of algorithmic trading, according to the experts. For one thing, there is little use of depth-of-book data. Some brokers believe that if their customers could see all of the available liquidity on a screen, they would have more confidence in algorithms to access that liquidity.