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The Future of Trading

10 Top CIOs on Wall Street |  Why Mutation Will Matter |  Buyside Traders: Not Taking Orders Any More |  Calculating Cost First, Trading Second |  Trading Desk, in One Box |  Changing the Minds of Star Programmers |  2015: The Always On Desk

Calculating Cost First, Trading Second

November 4, 2010
By Chris Kentouris

FX Transparency also provides fund managers with a comparative analysis of how well their execution costs rank against 100 fund managers. For those who want to improve their execution, the firm then counsels fund managers and plan sponsors on execution strategies. McGeehan declined to specify what those were for competitive reasons but claims that one plan sponsor is saving $5 million in costs annually based on FX Transparency's advisory work .


As more fund managers incorporate options into their trading strategies the need for transaction cost analysis becomes more obvious. But the continued widespread use of phone-based trading continues to prevent the buyside from capturing trade information and conducting TCA. And until recently the options market has lacked appropriate benchmarks.

“Due to the lower trade volume for options, traders need liquidity recovery, order flow, market impact, execution quality and trading cost metrics that rely on factors other than the Options Price Reporting Authority’s (OPRA’s) consolidated tape in understanding each transaction,” says Alan Shapiro, president of Transaction Auditing Group (TAG), a New York-based transaction cost analysis and execution quality provider. “That means a firm also needs to analyze all of an option’s quotes as well, which requires the capture and archiving of millions of market data ticks per day.”

One benchmark used by TAG is Gamma Weighted Average Price (GWAP) which incorporates equity and options tick data to benchmark listed option execution performance for the buy-side and sell-side. “Such an analysis resembles a volume-weighted average price for an equity security combined with option Greeks and premiums,” says Shapiro.

Five different Greek symbols represent factors that influence the pricing of options. Delta represents an option’s sensitivity to changes in the underlying price of a particular stock. Gamma is an even finer measure of the sensitivity of the delta itself to changes in the price of the stock. GWAP represents an understandable fair-price benchmark for the measurement of execution quality of institutionally-sized option orders. This benchmark is calculated based on trading activity over a period of time rather than on market conditions at a particular moment.

But do fund managers really need all the dizzying array of TCA tools? “It’s a bit overwhelming to understand the differences between each TCA service provider,” says one trader at a New York-based investment fund.

The trader says that while predictive switching is still a bit “avante garde” for all but the most sophisticated quantitative desks, advancements in algorithmic and high frequency trading has all but required all buy-side firms to understand – and embrace – the new technology. And ask more questions of their TCA providers on the differences in their methodologies and results.

Jason Lenzo, head of equity and fixed income trading at Russell Investments, a registered broker dealer and investment adviser in Tacoma, Wash., with more than $140 billion in assets under management, says that all of the data points and information do allow a firm to do better comparative analysis with its own trading strategies and metrics.

Russell uses multiple pre- and post-trade models, including both internally developed ones as well as third party, it declines to name . “The models rely on and sometimes share, a range of factors, including the percentage of volume provided or taken from the market, average spread, sector tracking bias, reaction to volatility and the number of times a print occurs in a day, says Lenzo.


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