When Spear, Leeds & Kellogg recently integrated program trading with single-stock trading on one platform, the move highlighted a quandary faced by brokers supplying customers with front-ends: Do they offer one system or two?
To some brokers, basket traders and single-stock traders are separate and distinct. Although it costs more, they are willing to maintain two systems. ITG, for example, offers Triton for basket trading; Radical for single-stock trading.
To other brokers, including Spear, Leeds, a division of Goldman Sachs, one system is the best approach. That's why it merged its TradeFactory basket trading front-end with its REDIPlus single-stock trading system. The reasoning? Basket traders want the ability to pull those stocks needing extra attention out of their baskets and work them separately.
Spear, Leeds' decision also speaks to the changes in its client base. When TradeFactory debuted in 1991, most of its users were broker dealers trading programs and index arbitrage strategies. At the time, TradeFactory was owned by TLW Securities, an electronic specialty broker.
Spear, Leeds bought TLW in 1999 in order to offer its clearing customers, mainly smaller broker dealers, access to TradeFactory. The move proved tonic for TLW as well. Between 1996 and 1997, the index arbitrage game had concentrated into the hands of fewer and bigger players, leaving TLW with a shrinking market for its services.
One year later, Goldman Sachs bought Spear, Leeds. The deal presented SLK with a whole new set of prospective customers for TradeFactory. Goldman Sachs is one of the top three prime brokers on the Street and hedge funds are serious basket traders. Some of Goldman's traditional buyside customers are looking at trading their orders in list form as well.
In sum, TradeFactory and Spear Leeds' REDIPlus system have been positioned to appeal to the buyside. The broker's broker still has plenty of sellside customers on its roster, but the directive from 85 Broad is to become buyside-friendly.
Europe is the fastest-growing market for the combined TradeFactory-REDIPlus product, where it appeals to both hedge funds and traditional money managers. Out of a total 70 users on the combined platform, 12 are in Europe. The rest are in the U.S. Also in the U.S. are 70 firms using TradeFactory as a standalone product.
Greg Tusar was one of the first three employees at TLW. He succeeded Tom L. Williams, founder of TLW Securities, last October, as the Spear, Leeds exec responsible for TradeFactory.
Traders Magazine Technology Editor Peter Chapman spoke with Tusar and his colleague Bryan Koplin about the integration of TradeFactory and REDIPlus as well as some brand new functionality being built into the integrated product.
Traders: What happened to the index market?
Tusar: As the markets got more efficient, that segment became dominated by larger broker dealers with a low cost of capital. [Profitability] became a function of your interest rate and access to capital. So, a lot of the smaller players in that strategy got squeezed out.
Traders: Then you no longer service index arb players?
Tusar: We do. The tools we developed on handheld devices for index arb are used by some of the market makers on the floor exchanges. They may or may not be our clearing customers. They use it to hedge derivative products they are trading in the crowds. So, if I am a market maker in the SOX options, for instance, I might use the same techniques and basket tools to delta hedge an options position that the larger broker dealer banks are using to conduct index arb on the S&P.
Traders: SOX is the Philadelphia Stock Exchange's semiconductor index?
Tusar: That's right.
Traders: These market makers are traditional SLK customers?
Tusar: SLK and First Options.
Traders: The large bank broker dealers have deployed their own systems?
Tusar: Right. They've migrated more to their own systems. [The business] is now very balance sheet intensive, and is dominated by broker dealers affiliated with banks.
Traders: The market makers on the derivatives exchanges is a new market for you?
Tusar: It has been around for some time and is a growing business for us. Other broker dealers that need basket trading…Introducing brokers to SLK are still a very large part of SLK's customer base and outlet for program trading technology. They use it to service their own customers.
Traders: What did the Goldman deal do for you?
Tusar: The Goldman acquisition opened up a number of channels that, as a smaller firm, we didn't have access to. Goldman has an incredible franchise in prime brokerage and a lot of the traditional long-only buyside – that neither SLK nor TLW had access to. So, the last two or three years have been dedicated to building functionality and content into the tool tailored to those client segments.
Traders: Such as?
Tusar: That includes things like algorithms, access to pre-trade analytics, European executions. Content that we can leverage from Goldman Sachs.
Traders: Algorithms?
Tusar: Access to algorithms has been one of the key focal points of the product over the past six to 12 months.
Traders: On the buyside, TradeFactory users are more likely to be hedge funds than traditional money managers?
Tusar: Hedge funds have been quicker to adopt the technology. But there is a segment of the long-only customer base that has been doing direct access trading generally for quite awhile. That is growing steadily, but at a slower pace than hedge funds.
Traders: Traditional money managers are still trying to decide whether or not they need basket trading?
Tusar: They are trying to figure out how programs fit into their workflow. Whether it makes sense for them to aggregate their orders.
Traders: Why integrate TradeFactory with REDIPlus?
Tusar: For a number of reasons. First, the SLK customers who had REDIPlus wanted basket trading. This is a much easier way to deliver it to them. Second, and equally important, people doing program trading needed the ability to focus on single stocks out of that program. It makes sense for them to take advantage of all the features in REDIPlus to do that.
Traders: O.K.
Tusar: We are alone among all our competitors to have that "best-of-breed" application. Market data plus book depth information plus news and charting. Everything you would need if there were a difficult stock in that program to trade. To really focus on it. Trade it as a single stock using algorithms.
Traders: And they don't want two systems on their desktops?
Koplin: It is consistent with the trend for firms to want integration and efficiency. So, why have two systems: one that specializes in waves and program trades. And another that specializes in single shares. When you can have two in one. You can further integrate that single platform into an order management system with your prime broker. And maximize real estate.
Traders: So, some orders that aren't getting executed must be taken out and worked?
Koplin: Yes. There might be liquidity concerns. It might be a stock that the trader has decided he wants to trade faster than the rest of the list. So, now that we have integrated it, you don't have to pull that out and trade it in a separate system. With a few mouse clicks you can exclude that stock from the list trading. Trade it as a single stock but still have a holistic portfolio view of how the overall trade is going.
Traders: ITG, with Triton and Radical, chose a different path. Your clients are different?
Tusar: No. We're going after the same clients, but with a different approach. We have a tool that is very good at portfolio trading. It addresses the concerns they are addressing with Triton. And REDIPlus is the Radical equivalent. But we see value in having the two exist on the same platform.
Traders: O.K.
Tusar: In any given program trade, the majority of impact comes from a small number of stocks. The whole art of program trading is finding out what those stocks are and addressing those particular ones while trading the rest of them in some automated strategy. List trading. That's really what we are attempting to address with the integration.
Traders: TradeFactory is divided into four categories: index trading, spread trading, portfolio trading and delta/gamma hedging. This is done to satisfy different customer needs?
Tusar: Yes. And each of those separate standalone tools has been integrated into REDIPlus as a separate window. Instead of as a separate application. The person doing the list trading wants to see different data on the screen than the person doing pairs trades. Different roll-ups of their trading data.
Traders: O.K.
Tusar: Someone doing portfolio trading will look at it on a portfolio level, a sector level and a single stock level. At how much of the trade they have completed. At stocks in which they may have impact. For pairs trades – we have a string that shows each of the different pairs that that trader is watching. We show how much they have completed. What their P&L is.
Traders: All four are integrated into REDIPlus?
Tusar: Only list trading and pairs. We are in the process of integrating our index arb application and our delta and gamma hedging model.
Traders: Delta and gamma is for options trades?
Tusar: Or convertible bonds.
Traders: You are introducing a new algorithm. What's that all about?
Tusar: There has been a lot of interest in algorithms that minimize implementation shortfall. As opposed to managing VWAP. Within the suite of algorithms developed by our algorithm team at Goldman Sachs is an algorithm called 4cast.' It attempts to minimize the impact of an order versus the market at the time the order was entered.
Traders: Isn't implementation shortfall measured from when the portfolio manager decides to trade?
Tusar: Correct. There are two pieces. In the first leg, the portfolio manager makes a decision to enter into a trade. The second is from when the trader begins to work the order until completion. This algorithm addresses this last leg.
Traders: How does it work?
Tusar: Users get a tool in which they can input a parameter that indicates how passive or aggressive they are willing to be. That either contracts or extends the amount of time the order will take.
Traders: That is automated?
Tusar: Yes.
Traders: Can you give me an example?
Koplin: You can be passive or aggressive. If someone puts in a passive 4cast order, that implies they are more comfortable with a longer time horizon for the order to execute. They want to have less impact on the stock. And leave a smaller footprint. If they are more aggressive, they are willing to make more of an impact. The opportunity cost of their not owning the stock is greater than the possible impact.
Traders: So, you're moving beyond VWAP?
Tusar: Yes.
Traders: How will your traders make that decision?
Tusar: We are releasing a pre-trade analytic tool that shows the user the trade-off between immediacy and impact graphically. So you can see the part of the impact that is due to time and the part of the impact that is due to opportunity cost as set by the user. Immediacy' has 10 levels and shows the user the optimal time over which to execute that order given that level of immediacy.
Traders: Please elaborate.
Koplin: The user must decide a risk preference. Is a 4' the right number for a stock? Is a 6?' A 2?' This graphical display populates and shows – according to transaction cost analysis and our internal models-what the expected time the expected risk or transaction cost will be. The user, instead of just submitting the order and finding out after the fact, can tweak a dial to see how those numbers and that graph changes.
Traders: Does the technology have a name?
Tusar: TheGuide.
Traders: How does the algorithm work? You use technology to scan and analyze market conditions?
Tusar: Yes. It is based on two things. First, there is an historical analysis of how a stock has traded. That is what our cost model is built on. But the algorithm is very sensitive as to how the stock is trading today and how that might be different from those historical patterns.
Traders: So, it takes into account both historical and current conditions?
Tusar: The algorithm does react differently. It will trade faster if more volume is traded in the stock. It will generally slow down if there is less volume traded versus historical patterns. The cost model is based on historical data, but the algorithm reacts to a speed-up or slow-down in trading. Based on today's trading activity.
Traders: Then you are scanning and looking at every tick?
Tusar: Correct.
Traders: The algorithm was developed at Goldman?
Tusar: The GSAT team came from Hull Trading. [Goldman bought Hull in 2000.] That's where a lot of the technology that underlies the algorithms came from. The techniques and algorithms Hull had built to do their trading. Short-term alpha models, etc. They have been incorporated into 4cast and VWAP algorithms.
Traders: Thanks, gentlemen.
