Long the purview of the pit traders, options trading is gradually becoming more electronic as the pressure to become efficient grows and the technology improves.
The trading of options, instruments which give the right but not the obligation to buy or sell stocks, futures, and other items at predetermined prices in return for a premium, has been moving toward greater electronification for roughly a decade. As much as 25 percent of options trades are executed electronically by investors in North America, according to data from research firm Greenwich Associates, released in October 2012.
More exchanges and clearing houses are moving in this direction. Case in point: At CME Group, electronic options trading on treasury options has grown to represent the majority of trades in just a few months. Electronically executed treasury options trades represented just 39 percent of all such trades in December 2011, but grew to 57 percent of all trades by December 2012. On February 1, 2013, total trading of treasury options hit a single day record.
Just over half of all options traded on CME Globex in December 2012 were traded electronically. This marks the first time ever that screen-traded options have outpaced pit-traded options. Overall, screen-traded options have grown 283 percent since 2009 when only 13.1 percent traded electronically.
Thomas Peterffy, founder and CEO of Interactive Brokers Group Inc. of Greenwich, Conn. and one of the founders of the Boston Options Exchange, believes that the increasing electronification of options trades has been a long time coming. An early advocate of using automation to make trading more efficient (going back to the 1980s), Peterffy says executing options trades electronically will make markets more transparent, which in turn reduces risk. Also, he believes electronically executed trades will have a lower error rate than pit trading elicits, which he estimates is still more than 1 percent.
Petterffy points out that the greater efficiency and the greater transparency of the electronic exchange of options means narrowing spreads. He estimates that in the past decade alone the spread between the bid price and the ask price have dropped to about one-quarter of what they had been. Similarly, he says, “commissions have come down a great deal.” Commissions, he estimates, are down 60 percent from where they had been before the electronic era.
Once a trade is in “electronic format,” it can move more easily from the trading desk to an institutional trader’s back office, which makes the process less costly, according to Andy Nybo, principal and head of the derivatives practice for TABB Group. There’s also less “touching” of the trade, which is likely to mean fewer errors, according to Nybo.
“For old-school end-users of FX options, the time has come to embrace the evolution of electronic FX trading,” says Howard Tai, senior analyst with Aite Group and author of a 2012 report on advances in foreign exchange options trading. “Especially in today’s environment, where establishing audit trails through electronic footprints on financial transactions is vital,” .
“Market-savvy traders with an affinity for speed and technology can choose from several levels of multi-dealer platforms,” Tai adds, “including a first-of-its kind, exchange-style ECN platform that comes with full anonymity and can cater to fully blown, API-driven algorithmic execution strategies and high frequency trading tactics.”
Nybo says the shift to more electronic options trading is simply traders embracing technology that offers them faster, more accurate trade execution. “As an institutional trader begins to trade more futures, they tend to gravitate toward something that meets their needs,” Nybo says. “If you’re an institutional trader trying to hedge a portfolio… you’re going to try to find ways to make the workflow more efficient.”