Rob Prior is CEO of Actant, a privately held software company based in Zug, Switzerland, that specializes in technology solutions for futures and options traders. He has spent over 25 years in the derivatives industry, beginning with Timber Hill (which became the market-maker arm of Interactive Brokers), an early adopter and innovator in applying electronic elements into trading. Prior spoke with JLN’s Doug Ashburn about the evolution of the market-maker space, current trends, and the future of trading.
Q: Those of us on the trading floor in the late 1980s – long before the advent of electronic trading – remember Timber Hill’s color-coded screens that fed real-time info to the traders in the pits. Did this give you an early appreciation for the importance of technology?
A: Back then, the whole idea of automated trading was considered outlandish when everyone else was sheet trading. We came down to the floor to be the first to automate trades between New York and Chicago. Everyone scratched their heads and said, “that will never work.” Now, here we are, 25 years later. All the pits have gone electronic, and everyone is trying to speed up that exact process and automate it even more.
Around 1990, we hooked up to the first electronic exchange, the DTB (now Eurex), and that was quite an experience, finally getting a chance to apply automation without human intervention. From there, we hit all of the electronic exchanges – LIFFE, SOFFEX, and the other early adopters in terms of electronic exchanges. Many of the tools and experiences our customers now have, we were developing them, or variations of them, way back then.
Q: What types of experiences?
A: Blips in the system, for one thing, where if you had a problem with an algorithm or an electronic trading system. When we started trading, there was no safety – no automatic cancellations [of trades]. Now our customers have the advantage of several layers of safeties. The exchanges have very sophisticated safety mechanisms in place. Eurex has delta-checks; you can set a delta limit where if you trade too many deltas at one time, it can hold all of your quotes [from the market]. In our system we have something built in called 10 trades in 10 seconds wherein if your strategy has gotten away from you, or there is some disconnect there, you are obviously doing a lot of trades that you don’t want to be doing.
Q: So, you are saying that you learned a lot of lessons the hard way back then that customers are now benefiting from? Can you sum up the lessons learned, or discuss some lessons that still need to be learned?
A: What is going on now is two-fold. First, there is the search for alpha – refining the various strategies across asset classes. The second is in the market-making sphere – how to control the quoting risk. Many market makers do not see the edge anymore in quoting all of the time, so they start to hold back, which takes away some of the liquidity. Some of the new tools are allowing market makers, as markets are getting tighter, to alleviate some of the pick-off risk.
Q: What are some of the ways you see market makers changing their businesses to survive this period, and even thrive within it?
A: One way is to expand a strategy across asset classes and across exchanges and regions. Another way is to get more creative. The standard market-making model is still there, it just may not be as lucrative as it used to be. This is where we fit in. We give customers the tools to write those complex strategies and be more creative. It used to be that the development cycle was six months [from idea to implementation]. With the new tools, traders are developing and tweaking strategies in real-time, and a viable strategy may have a shelf life of as little as six weeks.
Q: How have changes to the business of market making affected the business of market taking, i.e., market participants who are willing to pay an edge to the market maker in order to initiate or close out a position?
A: Of course, tighter markets make it more difficult for market makers, but better for the market takers. The age-old problem, though, has always been how to get size orders done in such an environment. Liquidity seeking algorithms in dark pools – the slicer-and-dicer algorithms such as icebergs, scale orders and VWAPs – there is a lot more refinement and progress that can be made in those strategies. Dark pools seem to be somewhat on the wane.
Q: That is a good segue into high-frequency trading (HFT), and some of the more advanced algorithmic strategies. How have they transformed the market?
A: First of all, there is some confusion over the nomenclature, in that a lot of automated traders and market makers tend to be lumped in with the high-frequency traders. High-frequency traders are really a specific, narrowly defined group within algorithmic trading. It appears to be on the wane in that the race to zero latency has turned into the race to fast enough.
Q: What does the future hold for electronic trading in the listed market space?
A: Clearly the trend is toward more automation, on both the buy-side and the sell-side. I was reading an article the other day that said the industry is about 60 percent automated. In a business such as this, at least 80, if not 95 percent should be automated. The market-making business is a cyclical one. We are probably right at the end of the five-year down cycle. I think soon there will be a lot more real volume back in the market, rather than the market maker to market maker, or to HFT.
In the future, firms are going to do more, find more, and trade more. Do more means that they are going to automate all of the ends of the trading process. That includes a lot of the maintenance tasks. We have algorithms that clean up the process. Find more means that, as the tools get better, they will be able to scan further afield and branch out into different markets. Trade more means that as markets become more automated, it will lead to more opportunity. Think back to the past, when you would watch another trader make a trade and say oh, I would have done that trade. With more automation comes the opportunity to participate in those trades.