Technology will be the most significant driver for growth in the US options market, as market-makers start to rely more heavily on automated black-box strategies, according to new research from consultancy TABB Group.
Andy Nybo, principal and head of derivatives at TABB and the author of ‘US Options Market Makers: Evolution or Extinction’, predicts that automated trading in options – which currently accounts for 60% of all market-making activity – will grow at a 6% compound annual growth rate through 2011, with leading firms spending up to $15 million a year to support their technological needs.
“Having the fastest quote engine, the speediest analytics or the fastest connection to an exchange is no longer sufficient,” said Nybo in a statement. “It’s not just black-box systems that are more critical. Phone- and pit-executed trades are declining as firms turn to direct market access (DMA) interfaces to more efficiently facilitate execution of complex orders requiring more trader attention.”
The study also found that market-makers are still adjusting to the consequences of the SEC’s penny pilot programme, which allowed the quoting of options prices in pennies rather than in nickel or dime increments, and will have to continue to invest in technology to manage rising data volumes, accelerated trading velocities and build automated trading systems. TABB estimates that the total industry spend for software, technology and systems supporting market-making operations is growing at a CAGR of 15%.
In the study, options market-makers revealed sensitivities about the algorithms and analytics they use to form their trading models. They prefer to build their own proprietary systems instead of using third-party solutions, TABB found.
According to Nybo, proprietary trading firms are set to make their mark in the options market using high-frequency, quantitative trading strategies, and estimates they will account for 19% of current trading volumes by 2011, up from 6% at present.
The study is based on 36 interviews, including 25 options market-makers operating on one or more of the 7 existing options exchanges. The participating firms trade roughly half of the total options daily volume.