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Using Corporate Event Data to Navigate Low-Latency in Equity Options: Strategies for Institutional Traders and Market Makers

Traders Magazine Online News, September 20, 2018

Barry Star

Options remain the closest community of market participants, and the murkiest. Even to its veterans, the options market can seem uncanny; its trading has always been full of mystery. Rumors abound of big-wins and equally huge losses turning on a dime, and there is common sleight of hand. It evolves at its own pace. But wild swings and tectonic shifts can also be born of simple mistakes. Such was the case in 2015, when a pair of microprocessor manufacturers was first reported to be in merger talks[1]. In only a few seconds, the news quietly generated a sizable option contract on one of the companies’ stock prices. Initially costing around $110,000 for more than 300,000 shares, the option went from completely out of the money to worth $2.4 million in less than half an hour.

The reporting subsequently proved wrong, adding intrigue and furrowing eyebrows. But in the end it wasn’t the windfall or the scant information that turned out to be significant; rather it was the speed. The option, most observers agreed, could only have been generated by an algorithm—an incredibly fast one, at that. While neither the first nor certainly the last, this was some of the most dramatic public evidence yet that low-latency and high-frequency trading (HFT) techniques had arrived—and for that matter, could work—in a space where they had only been casually embraced before.

Below we explore new trends in the development of event-based trading signals in the equity options market. Ultimately, we conclude that investors must construct a dual strategy—combining measurable post-trade execution quality analysis with pre-trade contextualized indicators of price movements—to effectively mitigate downside risk and exploit market inefficiencies with options.

The Challenge: Reading Corporate Tea Leaves

The growing cohort of investors represents a kind of ‘Goldilocks’ group of options participants. They are compelled to be able to execute in a few seconds, but without the need or wherewithal to move in microseconds. In short, timing matters. Equity options provide an effective way to play on ideas about a listed company’s price—be they changes in market sentiment one way or other, or mitigating short-term volatility. There are myriad ways to construct that option position, from simple binaries up to multi-strike butterflies and other wingspread strategies. Either way, doing so inevitably starts with the target strike (or strikes) and tenor for the option.[2] And they often focus in upon a corporate[3] event.

This exercise requires context—placing a premium on availability and the proper application of data.[4] Key characteristics of an option are shaped by isolating phenomena and information that drive changes in the underlying stock’s price. Indeed, some of the data points surrounding an event can be highly diverse, and at times hard to find. Their impact and relevance will be open to debate and, like the microprocessor merger mentioned above, crucial signals about the direction can sometimes come out of nowhere, or prove inaccurate.

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