U.S. buy-side trading firms are expanding their use of options and are turning to complex strategies such as multi-legged spread trades that are being executed through direct market access and algorithms, research firm Tabb Group said in a report.
The report noted that the buy side is investing in more powerful technology platforms – both in the front and back office – to support the growing complexity of their options tactics. And even though Tabb predicts options trading volume will decline 10 percent this year, the ground is now being laid for future growth.
"Options trading volume may be down across the industry, but the buy side continues to remain captivated with the potential of using options in their strategies," Tabb Group principal and head of derivatives Andy Nybo said. "These firms are exploring more efficient ways of managing risk exposures and doing so, they're expanding their product selection to include more VIX-related, ETF/index and listed FLEX options."
Brokers, meanwhile, are competing fiercely for order flow and are looking to entice the buy side with a range of services. But a broker's ability to commit capital is the key factor for buy-side traders when they're narrowing down where to send their order flow, Nybo added.
"Although liquidity of the option dictates how the trade is executed, often it's the size and parameters of the trade that require capital commitment from a broker," he said.
The research also found that a growing number of asset managers are routing their orders through low-touch trading channels. According to Nybo, asset managers routed 33 percent of their orders through such channels in 2011, up from 15 percent a year earlier. But it was a slightly different story for hedge funds. Nybo said hedge funds routed 63 percent of their volume through low-touch channels in 2011, down from 68 percent in the prior year.
"Asset managers told us they've expanded their use of direct market access and algorithmic trading tools in 2011 due to the rising complexity of their strategies," Nybo said. "In contrast, hedge funds relied more on high touch channels in 2011 in an attempt to reinforce relationships, given the lower volumes and commission dollars they are spending with brokers."