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Increased competition, new regulation and exchange consolidation have set the stage for a new era in automated trading of equity options in Europe, says TABB Group in new research today, “EU Equity Options Market Structure: Opening the Door to High Frequency Flow”. According to TABB, high frequency trading firms’ strategies are set to penetrate the European equity options market after implementation of MiFID II, which will see the introduction of new organised trading facilities (OTFs) established by interdealer brokers (IDBs). OTFs are expected to serve as new, easy points-of-entry for high frequency liquidity providers, bringing growth in trade volumes and tighter bid/ask spreads.
“While US listed options volumes have grown at a compound annual growth rate (CAGR) of 20 per cent since 2002, Europe’s listed options market grew at a comparatively flat CAGR of 5 per cent, as institutional and hedge fund equity option order flow stayed away from exchange trading,”, says Will Rhode, author of the new report and a senior analyst at TABB Group Europe in London. “Without sufficient liquidity found on-exchange, specifically with single-stock options, buy-side firms choose to execute block-sized orders over-the-counter (OTC), which is why only 26 per cent of notional turnover of European single-stock options traded on exchanges in 2010, compared to 74 per cent in the OTC market.”
Other obstacles limiting market transformation have included a lack of product fungibility; intellectual property rights issues; a fragmented IDB landscape; and the predominance of vertical clearing silos. But the process of change has already begun. “Many of the traditional boundaries are being tested, if not breached”, Rhode says, “and the speed with which change will occur is likely only to accelerate”.
The proposed Eurex/Liffe merger, he explains, will combine the two largest equity derivatives markets in Europe, bringing concentrated liquidity, cross-margining and netting into a single marketplace. “This will go a long way towards reducing the overall cost of clearing that regulation threatens to impose and for the first time establish a viable exchange alternative to the dominant OTC market.”
Whether trading occurs on OTFs, multi-lateral trading facilities, single-dealer platforms, multi-dealer platforms or simply an exchange, Rhode writes that “the days of manual dominance are coming to a close in Europe. With the advent of more electronic trading platforms will come new market participants, like high frequency liquidity providers, with the power to make Europe’s equity options markets deeper, more competitive, more tightly priced and far faster than ever before.”