US options traders drop DMA and pick up the phone

US asset managers have cut back on DMA for options trading with 97% preferring to use the phone in 2010, up from 91% in the previous year, according to a new study from consultancy TABB Group.
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US asset managers have cut back on DMA for options trading with 97% preferring to use the phone in 2010, up from 91% in the previous year, according to a new study from consultancy TABB Group.

The report, ”US electronic options trading 2010: algorithms, DMA and crossing networks', argues that dependence on broker capital and the need to trade in large size are limiting the adoption of algorithms among traditional buy-side traders.

“Traders looking to move size do not trust an algorithm to trade in these instruments; instead they use broker capital or work the order themselves,” read the report. Sixty-three per cent of respondents argued that access to capital was the main obstacle to electronic trading, with 33% citing better pricing by phone and 29% stating that phone trading “adds market colour.”

However, Andy Nybo, a TABB principal and author of the report, predicted that cost pressures could cause a shift in the buy-side's use of execution channels for options.

“One begins to question the rationale of executing via high-touch channels and paying double or triple the going rate for electronic executions, especially for more liquid options,” said Nybo. “At some point, lower commission rates for electronic execution will become undeniably attractive.”

There will be appetite for using algorithms around more liquid options the study indicates. According to TABB, options that trade via order-driven protocols, for example options that have a strike price equal to the value of the underlying asset, thereby having little intrinsic value, with impending expiry dates, would be most suited for electronic trading by buy-side firms.

Hedge funds by contrast had increased proportion of order flow through algorithms from 9% in 2009 to 23% in 2010, and expected to grow further to 31% in 2011.

Participants in TABB's study comprised mainly hedge funds (61%) and asset managers (33%), with US$2.5 trillion of combined assets under management.

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