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But try to consolidate across both complexes and the challenge becomes exponentially greater. A further consideration is the change underway in option markets. The penny pilot program has enabled high frequency trading strategies to proliferate, which for those accustomed to the certainties of an environment where there were clear market maker obligations represents a whole new layer of execution complexity.
The exchanges are obviously aware of the difficulties confronting traders wanting to operate across equities and equity options and have tried to assist with mechanisms that allow one stop package trades including both. They offer traders "spread" books that allow quoting and trading in "pre-packaged" spreads. While this offers a measure of certainty i. In effect, greater certainty comes at a significant opportunity cost of vastly reduced access to liquidity.
Although the spread books do have some liquidity, in this fragmented high frequency world, finding the best possible execution in sufficient size requires a platform that can aggregate the largest possible number of liquidity sources for both equities and options. Moving from trading the "package" to managing aggregated liquidity across multiple venues introduces additional execution risks. The right algorithmic execution tools are needed to negate "leg" risks.
Optimal execution requires a single consolidated transparent interface and sophisticated execution algorithms.
It also has the virtue of making the most efficient possible use of available desktop real estate. However, while existing pair algos may work well for equity pairs, a different approach is often required for equity options. Liquidity in the options market can have a very different profile than equities; naively applying a conventional equity pair algo to the options market is susceptible to market impact by continually pushing to execute.
For example, an algorithm that constantly trades when the pair hits the desired spread may hold the market from providing price improvement and potentially signal to the market that there is an algorithm at work. While sourcing equity and option liquidity across multiple venues has implicit legging risks, these can be minimised with the right tools. Most applications have a rather limited response when a leg gets hung up; they either immediately go to market or pop up an alert.
Neither response is particularly helpful; the first increases execution costs perhaps substantially , while the second compels the trader to react possibly prematurely. Better alternatives include allowing the trader to specify a time limit before further action, in case the market drifts back in the right direction of its own accord.
If this doesn't happen, a second stage would be to enable the trader to grant the application a specific degree of price discretion. A further method of maximising control of a multi-legged trade that includes equity options is pegging. In an ideal world, the trader needs the facility to peg each leg of a trade to a benchmark, which could be volatility or delta or just a target spread value. Upper and lower bounds set on either side of these benchmarks can then be used to control the execution algorithm behaviour, such as pauses.
A further advantage is if the pegging is in line with a market benchmark. As the underlying equity rallies, the trade becomes less attractive. Strategies that combine equities and options can easily create a risk management and book-keeping nightmare. Therefore any trading application needs to be tightly integrated with both the trader's blotter and middle and back office systems.
A common situation where this degree of integration is especially valuable is where the trader is working in the same name across multiple strategies. A very simple example of this would be selling multiple calls delta neutral against the underlying stock but where only half of these were a vol sale, while the remainder were part of a vertical spread. The ability to both separate and combine the view of these transactions hugely simplifies risk management and back office admin, as well as minimising operational errors.
By the same token, being able to access the application's functionality in another trading application such as an execution management system also adds significant workflow value. For example, many traders like to be able to run a potential strategy in simulation mode and then activate it with real capital if performance proves satisfactory.
Therefore the trading application needs to be tightly integrated with analytical and graphical tools that will allow the calculation and display of all risk factors associated with the strategy, both historically and in real time. While there might once have been a measure of truth in this, times have changed. Options involve risk and are not suitable for all investors.
For more information, please read the Characteristics and Risks of Standardized Options. For an updated copy please visit the OCC's website http: Bloomberg Tradebook is a global agency broker offering advanced trading algorithms and direct market access to over 60 global equity, futures, and options markets and 41 currency pairs in our Foreign Exchange marketplace.
Now, using the same connectivity as Bloomberg's data API, traders can integrate their strategies with Bloomberg Tradebook's high performance Order API and connect their strategies to the electronic execution highway. Nothing in this document constitutes an offer or a solicitation of an offer to buy or sell any security or other financial instrument or constitutes any investment advice or recommendation of any security or other financial instrument.
This communication is directed only at persons who have professional experience in the investments which may be traded over the systems and certain high net worth organizations. Available in all countries and is only offered where clearance has been obtained.