July 20, 2010

Trading Goes Beyond the Edge

We were in Lake Jackson, TX, last week for Karen’s HS reunion. South Texas is a sweat lodge this time of year, but the Saint Augustine grass lies lush and luminescent under the sycamores and live oaks. And we saw not one tar ball on Surfside Beach in Freeport.

A word on trading: We expected money to move after options expirations, but changes to program-trading plans came early, on July 14, we observed in the data. So with expirations July 15-16, markets were shellacked when money shifted to other assets. The past two days have given us massive arbitrage around this shift and ahead of tomorrow’s volatility expirations. Thus, the week could end on a rough note, we fear.

Switching gears, you’ve heard of Direct Edge? It came out of Knight Capital Group and has for many years operated Electronic Communications Networks, or ECNs, called EDGA and EDGX. One was for active algorithms, the other for passive black-box trading systems, in essence.

In 2008, Direct Edge traded Eurex, the operator of the International Securities Exchange, a 31.5% stake for the ISE Exchange. Started ten years ago, it was the first all-electronic options exchange, and it’s one of the globe’s biggest such, offering electronic trading in options for more than 2,000 equities, ETFs, indices and foreign-exchange products. Eurex is itself owned by the German and Swiss exchanges, the Deutsche Borse and the SIX. Direct Edge is partly owned also by Citadel Derivatives, Goldman Sachs and Knight.

With the advent of two new Direct Edge full exchanges tomorrow, EDGA and EDGX, the ISE Exchange will be blended in and discontinued.

Why does this matter to IR? You need to know what’s happening out there. Direct Edge routinely handles nearly a billion traded shares daily. Its platform best serves highly automated volumes in multiple asset classes. It commands about 12% of total equity volume. Its growth mirrors the explosion of global high-frequency trading in equities and other asset classes.

Like other trading innovators, Direct Edge sees growth opportunity in the evolving nature of trading. Both NYSE Euronext and the Nasdaq operate two options exchange each, and midcontinent rival Bats Exchange got approval in February this year for an options exchanges. Direct Edge hopes to offer simultaneous trading in many things – currencies, commodities, stock loans, futures, options, equities.

Why operate exchanges rather than alternative trading systems? It lowers clearing costs, expands data revenues from the consolidated trading tapes (exchanges get a better share than ATS’s), and opens doors to more products for traders.

For IROs, it’s a window into what’s behind price and volume. These are things you have to know now. Markets are fragmented and trading is spread across asset classes. It’s akin to the digital book market. Amazon is now selling more hardback books via the Kindle than in print. That’s how customers are consuming books.

How are customers consuming your shares? One big key to longevity in the IR chair is becoming the source of data and information about trading. We can’t control how traders use liquidity – but we sure can become expert at understanding how it works.

And from that knowledge comes the power to change markets. Or least understand them — and that’s both cool and valuable these days.

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