HFT ‘to shake up Europe options market’ - FT.com

High frequency trading is set to shake up the opaque European options trading market in more or less the same way it has transformed cash equities in recent years, a new report has found.

A study by Tabb Group, the US-based consultancy, forecasts that the firms, which use cutting-edge technology to trade in and out of shares in fractions of seconds, will use the new trading platforms created by incoming European regulation to spearhead an aggressive push into European options.

The findings come only a day after a separate Tabb report found that European use of US options for trading had risen between 30 per cent and 73 per cent compared to a similar study conducted in 2005.

The report, commissioned by the Options Industry Council, found that 10 per cent of volume in US-listed options originated from Europe in 2010. Although that number represented a decline from the 15-20 per cent market share Europe held five years ago, Tabb pointed out that total US options market volumes had soared to 3.9bn contracts from 1.5bn in 2005.

Market infrastructure operators have been preparing the ground for a shake-up of European derivatives trading in recent months. Turquoise, the dark pool owned by the London Stock Exchange, has launched equity derivatives in a bid to take on rivals NYSE Euronext and Deutsche Börse, which collectively dominate European derivatives trading. The two companies are also planning to merge to create an overwhelming position in futures and options trading but face an in-depth probe from European antitrust authorities. A decision is due in December.

At the same time, European regulators are pushing through a review of European trading rules contained in the Markets in Financial Instruments Directive (Mifid) which will see large parts of the vast but opaque over-the-counter (OTC) derivatives market traded on exchanges and “organised trading facilities” (OTF) – an as-yet undefined new type of trading platform.

Will Rhode, author of the report, said the changes would provide more transparency over pricing and lead to competition between interdealer brokers, exchanges and broker-dealers to provide the best OTF, the gateway for high frequency liquidity providers.

The growth of high frequency trading on cash equity markets in recent years has been controversial. Its proponents argue that the practice increases trading volumes and tightens spreads on prices. Detractors say their often aggressive tactics amplify market volatility. It has grown to account for around 60 per cent of daily average volume in US markets and around a third of European trading.

There are, however, stark differences between US and European options markets. The former is a highly liquid and regulated market, while Europe is more opaque, with business often conducted by interdealer brokers.

Mr Rhode estimated US listed options volumes had grown at a compound annual growth rate of 20 per cent since 2002 but Europe’s listed options market has grown at a rate of 5 per cent in the same period.

“Without sufficient liquidity found on-exchange, specifically with single-stock options, buyside firms choose to execute block-sized orders over-the-counter, which is why only 26 per cent of notional turnover of European single-stock options traded on exchanges in 2010, compared to 74 per cent in the over-the-counter market,” he said.

However, he said there were some obstacles to further development of the European options market. They included uncertainty over clearing, a lack of product fungibility and monopoly ownership of tradeable products. Ownership of an index allows exchanges to spin off new derivatives contracts based on them, locking out rivals.

by Phillip Stafford Financial Times Sept 7, 2011


HFT ‘to shake up Europe options market’ - FT.com