Crossing networkstake on options

NEW YORK — Crossing networks are moving into options, hoping to extend to money managers the same benefits they have achieved in the equity markets — matching large orders at the best possible price.

Ballista Securities LLC, New York, on Sept. 9 launched its electronic platform with a patent-pending auction feature for blocks of at least 500 contracts.

The platform combines liquidity aggregation, anonymity, multiple trading strategies and complex orders involving delta-neutral or offsetting options and stock positions. One options contract typically represents 100 shares of the underlying stock.

“We are trying to solve one of the primary problems we see with fragmentation in the options market,” said Robert Newhouse, Ballista chief executive officer.

3D Markets Inc., Hope, Pa., targets even larger orders of at least 5,000 contracts for its Archangel platform and is awaiting approval from the Securities and Exchange Commission to launch an innovative gamma-weighted average price cross. 3D is in an exclusive licensing agreement with the Chicago Board Options Exchange to launch the GWAP benchmark price, which is based on the same principle as the volume-weighted average price commonly used in the stock market.

While options volumes have seen record-setting growth in the past five years, liquidity is fragmented among seven U.S. options exchanges, which are partly or fully electronic. The arrival of penny quoting in a market that used to trade in 5-cent and 10-cent increments is compounding the problem as liquidity is now also spread across multiple price levels.

“There is a very large pool of passive liquidity from the banks and hedge funds, but they have no electronic access (to their potential match),” Mr. Newhouse said.

“We (at Ballista) are providing a new method of sourcing liquidity from the buy side to the sell side,” added Mr. Newhouse, who said his crossing network is for members only — institutions, brokerage firms or other liquidity providers. Orders are exposed to a five-minute electronic auction process after which they are executed at the best price.

Jason Ungar, director options-trading firm Ansbacher Investment Management Inc., New York, agreed that asset managers' access to more electronic execution is a plus, but he expressed some reservations about the ability of the new venues to solve a supply/demand imbalance inherent to the options market.

“The problem is that, typically, you are still going to have much greater buying pressure on equity index options than you have selling pressure,” Mr. Ungar said. “There will always be demand to hedge S&P 500 positions, but there's not going to be an endless pool of sellers to cross it. There are simply not that many natural sellers on the buy side.”

To avoid the information leakage related to very large options orders, asset managers often execute those transactions over the counter, a one-on-one options contract against a counterparty large enough to take the risk, usually one of a dozen major securities firms.

Many of those firms have been hurt by the mortgage meltdown and are far more cautious about committing capital or taking risk, which might provide the right backdrop for the budding crossing networks to provide a new way of moving large orders.

“One of the reasons for the phenomenal growth on the OTC options-trading side is the desire to avoid the front-running associated with listed options,” said 3D Markets President Jeromee Johnson, referring to the practice of professional traders taking positions ahead of an upcoming order.

While OTC options contracts are negotiated at a price mutually agreed upon and without any information leakage, like any one-on-one transaction, they carry counterparty risk.

But crossing networks would simultaneously solve the order anonymity and counterparty risk issue, because all their trades are reported to an exchange and cleared by the Options Clearing Corp., Chicago.

3D Markets’ blind-bid cross provides minimal information about an order, making known its characteristics rather than its specific details. The firm also hopes for something of a revolution by introducing a GWAP benchmark in the options world through its partnership with CBOE.

“3D is bringing the VWAP concept to options, so that large trades can be done with minimal impact, the target being the large institutional customers,” said CBOE Executive Vice President Edward Provost, who added the order type would work particularly well for options on the S&P 500 index, commonly used to hedge portfolios.

Contact Isabelle Clary at [email protected]