A joint venture between the Chicago Board Options Exchange and a division of agency brokerage Pipeline Trading to offer a crossing mechanism that prices block trades at the gamma-weighted average price (GWAP) is back on track, according to a principal involved.
Pipeline Archangel, formerly 3D markets, the brokerage firm that devised the idea of a GWAP benchmark cross is in talks with systems developers to finally build the much anticipated crossing system, according to Dave Mortimer, the head of Pipeline Archangel.
Mortimer, who had been busy merging 3D Markets into Pipeline Trading earlier this year, is expecting the CBOE will be able to begin offering the system to its members in the fourth quarter or next year’s first quarter.
"Getting the [Pipeline] deal done certainly delayed the project," Mortimer said. "But Pipeline has a huge IT department and great project management folks. It helps a lot."
The New Hope, Pennsylvania-based brokerage and the CBOE announced the plan to bring benchmark trades to money managers with large options orders over a year ago. So far progress to bring the concept to fruition has been slow.
The two parties as well as other trading executives believe that creating a benchmark and an electronic facility to match block-sized orders would stimulate options trading among traditional asset managers much the way the VWAP benchmark has done in cash equities.
Although the VWAP benchmark has been losing favor among traders in recent years, it is still widely used. A GWAP benchmark is harder to construct however and Mortimer’s team is in talks with money managers about the best way to perform the calculation.
One sticking point is the choice of implied volatility, a key factor used in options pricing models to determine the value of the option. "Do you use the opening implied vol?" Mortimer asks rhetorically, "Or do you use some sort of 10-minute average of implied volatility?"
Building the matching system itself is not an overwhelming task, Mortimer notes. Pipeline is in discussions with several outside developers and expects to arrive at a decision in the next few weeks. Construction of the system will likely be outsourced, Mortimer explains.
Another sticking point is the need for Securities and Exchange Commission approval of an after-hours cross. There are no after-hours prints in options like there are in cash equities, Mortimer explains. The CBOE must file for a rule change with the SEC to enable one. Mortimer is optimistic the SEC will authorize the change.
For the venture to be a success, the GWAP benchmark must be accepted by money managers and their brokers. A typical trade would involve a buyside trader asking his bulge broker to take the other side of his trade using the broker’s capital. The broker would simultaneously hedge the trade and print it at the CBOE at the full day’s GWAP.
At least one executive at a bulge shop is bullish on the idea. "I’m not predicting they have the mousetrap that will change the world, but I do think the market is ripe for somebody to come through with a breakthrough," said the trader who asked to remain anonymous. "The potential breakthrough is GWAP. Now you have a benchmark you can measure your traders against and a venue that provides that for you. So maybe it won’t be ships crossing in the night. Now you could have a place where you could actually cross. You are going to hold your traders to that and maybe that standard starts to apply where you start to work more orders."
A trader on the buyside is eager as well. "How else do you evaluate how your execution turned out?" Jen Setzenfand, vice president and senior trader at Federated Investors, asked rhetorically. "The quality of the benchmark is important though. But we don’t have anything now, so let’s start with something and build from there."