Hedge funds and traditional asset managers in North America will spend as much as $305 million on low-latency options trading infrastructures in 2011, up from $253m in 2008, according to estimates by Tabb Group, a research firm. This represents a compound annual growth rate of 6%.
The increasing technology demand follows continued growth in the listed options market, according to Tabb’s latest study, ‘Low-latency options trading: unravelling the true meaning of speed.’ Although Tabb expects the use of complex structured products on Wall Street to decline and the credit markets to become more regulated, it said growth in the exchange-traded options market is accelerating.
In 2008 to date, listed options trading volume has grown to and average of 14.6 million contracts daily, according to the Options Clearing Corporation, a 28% increase from the 11.4 million daily average seen for the full year 2007. “There is considerable room for growth in options trading volumes, especially from high-frequency trading strategies that require low-latency applications,” said Andy Nybo, senior analyst and head of Tabb’s derivatives research service, in a statement. “IT vendors who can understand their clients’ needs and traders who understand where reduced latency can enhance profits will ultimately gain.”
According to the study, electronic trading has been a catalyst for the volume spikes witnessed during the past two years.
“Financial firms on both the buy-side and sell-side are looking at new ways to profit from technological innovation and increased market accessibility,” said Kevin McPartland, senior analyst at Tabb and author of the report, in a statement. “Although trading strategies vary wildly amongst market participants, a single element takes centre stage repeatedly – speed.”
While economic forces and easier access are driving demand, regulations and changes in market structure are affecting how market makers, hedge funds and proprietary trading desks generate profits, the study said. Combined, these factors increase the need to process massive amounts of incoming market data through direct feeds, making trading decisions and executing on the exchange faster.
Tabb estimates that buy-side firms in North America will spend $17 million in 2011 on direct feeds for options trading, not including the cost of additional technology necessary to implement the incoming data. McPartland notes that because hardware solutions are well suited for the options environment, technology vendors are working to integrate hardware acceleration and more traditional, software-based messaging into a single solution.
As trading algorithms and smart order routing have been embraced by options traders, so has the use of complex event processing (CEP) to power them, the study said. As a result, Tabb forecasts that the buy- and sell-side’s spending on CEP to support options trading will grow at a compound annual rate of 12% between now and 2011.
While noting the growing importance of low-latency applications for options trading, McPartland added that there is a desperate need for a better definition of low latency at each stage of the options trading process – when market data is received and disseminated, trading opportunities identified and validated and orders generated. He said, “Options are not equities, pricing analytics are not quote engines and neither should be measured on the same scale.”