US buy-side traders will increase their use of execution algorithms in the options markets over the next two years as they employ more complex trading strategies and cut costs, according to a new report from consulting firm Tabb Group.
The report, ‘Options algorithms: moving beyond the smart order router’, estimates that industry spending to support algorithmic trading in options will grow to $216 million by 2010 from $191 million in 2008 – a compound annual growth rate of 26%.
According to Andy Nybo, senior analyst at Tabb and author of the report, buy-side traders are increasingly incorporating complex mathematical analysis into real-time trading decisions, creating the need for systems that can cope with a more intensive, technology-driven trading environment. “As complex strategies become more commonplace, traders are turning to algorithms to automate transaction processes,” he said in a statement.
The report also said today’s advanced options algorithms can be used to replace over-the-counter (OTC) agreements. For example, large trades can be disguised using liquidity-seeking or order-slicing algorithms, specific volatility exposure can be created through multi-legged, contingent order algorithms, and hedging programs can be managed using delta-hedging algorithms. “As the buy-side begins to evaluate their strategies in light of the higher cost of capital, they can be expected to use algorithms as a less expensive solution to OTC activities,” said Nybo.
The increased use of algorithmic trading tools will add to the growing trend towards low-touch trading, the
report said. To attract order flow, Tabb expects the sell-side to continue to enhance its electronic trading services by building more functions into their trading systems. Thee include analytics, pricing, order routing and multi-asset capabilities.