In the Footsteps

Ballista didn’t make it. Will Emergent have better luck?

Emergent Trading Solutions, a start-up vendor of execution management technology, is trying to drum up interest in an electronic auction mechanism for the trading of large options orders. The firm is positioning the platform as an alternative to capital commitment by large institutional brokers.

“There’s no price competition for orders effected between a broker-dealer and a buyside,” noted Emergent president Steve Lynner. “In some instances, that’s a good thing. But for other orders, the buyside may want to have price competition. Also, there’s a whole strata of institutions that can’t get access to capital.”

Lynner was president of Thomson Financial’s AutEx division from 1998 to 2003, when the organization introduced TradeRoute, an order-routing system for the equities business. After that he was hired to turn around a floundering Davidge Data Systems, where he built an options order management system. The technology was used by market makers Citadel Securities and Knight Capital Group, now part of Citigroup.

Lynner has headed Emergent for the past three years, and in March released an execution management system called ModelRoute. He has found no takers as yet for the product and is hoping the addition of an auction platform will make it more attractive.

Slotting an auction marketplace into the existing structure of institutional options trading may not be easy. Ballista Securities, now owned by a futures trading outfit, was built around an auction mechanism. Intended as an alternative to the traditional interdealer broker, the platform never gained traction with the buyside and eventually withered on the vine.

Lynner is undaunted. He argues that his platform offers more transparency than Ballista’s, making it akin to a public bulletin board. This should guarantee a wider audience, he contends. The exec also maintains that his business model is more broker-friendly.

Still, options industry executives say the start-up faces big challenges. Because the buyside is comfortable with the status quo, changing its behavior won’t be easy.

“You need both the buyside and the sellside to embrace this in order for it to work,” said John Duffel, Instinet’s chief strategy officer, and founder and head of Torc Financial, the options brokerage Instinet bought in 2009. “If they are not ready for that, then I don’t see this as being any more successful than Ballista.”

Indeed, even the former head of Ballista expects Emergent to find the going tough. Rob Newhouse, now chief executive of Victortek Technologies, a vendor of risk management and analytic software to options traders, says the hurdle is getting the software on the buyside’s desktop.

“You need to have people who are dedicated to providing orders into the system,” Newhouse said. “It’s easy to find liquidity providers because options order flow is very profitable to trade against.”

Part of Ballista’s undoing was an inability to convince buyside traders to put the software on their desktops, Newhouse explained. That limited the amount of orders submitted to the auction.

As with any new technology, the goal is to automate an existing manual process, making it more efficient, less time-consuming and less costly. Lynner says his platform will do all that.

The system brings together buyers and sellers and then routes any matched trade to an exchange for printing. Intended users are the buyside and/or their brokers. The system would handle single-leg, multi-leg, tied-to-stock or FLEX orders.

To start the auction process, a buyside trader enters an order. The details of the order are then are made available to an electronic crowd. The crowd can then respond by providing a price if the option is exchange-listed or an implied volatility if it is a Flex option. The order originator can run the auction for as little as one minute or as long as 30 minutes. Because general market prices for the option and the underlying are likely to change during the auction period, Emergent’s system will update the prices of all parties.

Lynner is especially enthusiastic about the platform’s potential for the trading of Qualified Contingent Cross and Flexible Exchange, or FLEX, orders. Both order types are institutional products that are put together in the upstairs market and then brought to an exchange for completion.

QCC orders are options orders paired with stock orders for hedging purposes. To maintain the pricing parameters of the hedge, they are permitted to be printed on an exchange intact, or without participation by member firms. FLEX options are contracts with non-standard terms traded on exchange floors. Designed to compete with over-the-counter options, their success has been limited.

The new Dodd-Frank legislation may change that. The law requires Wall Street to move as many OTC derivatives trades onto central clearing platforms as possible. Lynner and others are betting the move to central clearing could bring trading out into the open as well and onto exchanges. That could prove a boon for FLEX contracts. “We’ve had extensive discussions with the Options Clearing Corp. about this,” Lynner said. “They are very interested in seeing this happen. They want the OTC volume.”

Emergent’s goal is to establish the platform as a facility of an exchange. It has held talks with several, Lynner said. If that doesn’t work out, Emergent would apply for a broker-dealer license and become an introducing broker. Either way, Emergent wants to be considered a partner to brokers, not something that completely replaces them.