Wednesday, July 29, 2015

The Growth of Italian Equity Derivatives: A Conversation with Borsa Italiana

Borsa Italiana's Massimo Giorgini.
IDEM, the Italian Derivatives Market of Borsa Italiana, part of London Stock Exchange Group, is enjoying another strong year in terms of volume growth, making it one of the most interesting equity derivatives markets in Europe. Its flagship products—FTSE MIB index futures, mini-futures and options—are enjoying buoyant performance thanks to increasing interest from both sell-side and buy-side investors globally. Massimo Giorgini, Head of Business Development for Equity and Derivatives Markets at Borsa Italiana, took the time to talk with us about recent developments at IDEM.

TT: Let’s take it from the top. Massimo, can you talk a little bit about your line of business?

Massimo: Borsa Italiana has operated the IDEM market since November 1994, so we recently celebrated its 20th anniversary. IDEM is the leading global liquidity pool to access Italian equity derivatives, offering the full suite of Italian equity derivatives, including futures, mini-futures, options, weekly options on the FTSE MIB Index, plus the full range of Italian single stock options and futures—not only on Blue Chip symbols but also on some Mid Cap names. FTSE MIB index futures, mini-futures and options also can be bought and sold in the U.S. in accordance with the terms of the No-Action letters from the CFTC and SEC.

Friday, July 24, 2015

Negative Electricity Prices: Do We Get Paid for Turning on the Lights?

Source: KQED

Possibly, but rarely

The majority of financial market participants would agree on the dogma that commodity prices can never be zero or negative. However, it is not always true in the electricity markets. While zero or negative prices aren’t especially common, they do occur. This can create real chaos in many financial calculations. For example, for an asset with a negative price, dividing by the previous price will give an undefined or misleading result if prices are zero or negative.

The electricity market price—just like a price of any other commodity—is driven by the economics of supply and demand, which in turn are determined by several external factors such as climate conditions, seasonal factors or consumption behavior. To better understand the reasons for the negative prices, one needs to look further into the mechanics of the electricity generation process.

The theory

In the electricity markets, power producers generate electricity at a scheduled rate. Power grid operators oversee the transmission lines, also called the transmission grid. Due to the physical properties of electricity, it is almost impossible to store the excess during periods of low consumption for later use during periods of high demand. If consumption is low, the only way to bring the balance into the demand/supply equation and preserve the transmission line’s integrity is to shut down the power plant.

Friday, July 17, 2015

All Washed Up: Putting an End to Self Trading

Last week the CFTC issued a report detailing the flash crash experienced in the U.S. Treasury cash and futures markets on October 15. The report highlighted the lack of a "smoking gun" culprit as the cause of the sudden and dramatic price swing witnessed in these markets. Instead, it pointed the finger at a culmination of many factors, including downward pressure on yields leading up to the event combined with an economic data release which contradicted the market’s expectations of a rate increase. It also highlighted another phenomenon prevalent in today's highly automated markets: self trading.

Technology to Blame

According to the CFTC report, nearly 15% of all transactions were "wash trades" during the period in question, meaning the same person—or two people trading the same account—represented both the buyer and seller on a trade. While this is an incredibly high percentage, what is more troubling is the fact that the average daily percentage of self trading on the cash Treasury markets is nearly 6% of all volume according to the agency’s report. Even though wash trading is typically forbidden in futures markets, it is nevertheless a common occurrence as trading systems and strategies grow in complexity and capabilities.

Source: Nanex
Many exchanges have built self-match prevention measures into their matching engines, but they are an "opt-in" feature and are largely considered a blunt instrument trying to solve a more nuanced problem. Self-match prevention is also increasingly under the regulatory microscope due to its role in facilitating spoofing: the assumption goes that if a spoofer is really looking to sell, he or she can put a large bid into the market to encourage other buyers to join and then sell through the level he or she was bidding. This has the effect of creating the necessary size into which the trader can sell while relying on the exchange to safely cancel the resting bid when self-match prevention is enabled.

For many years, TT helped in addressing this problem with a similarly blunt instrument: Avoid Orders That Cross or, as our customers call it, AOTC. This feature gives users two options when an inbound order would cross a resting order of their own: reject the former, or cancel the latter. AOTC, which is optional, helps trading firms and clearing firms avoid the potential fines associated with significant wash trading. Whereas most exchanges historically gave warnings for the occasional and clearly inadvertent wash trade, increasingly they are cracking down on the practice with stiffer penalties.

Frequently, wash trades occur because traders deploy many simultaneous trading strategies that trade many instruments, often with overlapping contracts and with pricing logic that can sometimes contradict each other. Given the right series of events—and the right level of volatility—it is not uncommon to see two different algos attempt to take opposite sides of the same contract. Features like AOTC were tailor-made to address this type of self trading.

But unfortunately there’s a scenario in which this can occur that is even more difficult to prevent and for which a feature like AOTC does not help. Many large, geographically-distributed trading groups trade on separate sub-accounts that all roll up to a single position owned by the parent company. This is prevalent particularly with large physical commodity trading groups, which often have branches in many cities worldwide but share a common purpose: to hedge the firm’s commodity risk.

Often when two traders who trade the same products sit next to each other at one of these firms, they’re usually aware of each other’s positions. If they determine they are working opposite sides of the same (or related) contract, they’ll simply transfer the risk on their internal accounting system. If trader A is looking to become long 500 contracts and trader B is looking to short the same, they can agree to cancel their working orders and offset each other’s positions; to the parent firm the risk is no different than if they actually traded with each other on the exchange’s central limit order book. But this practice is obviously made difficult—and usually impossible—as the number of traders and the distances between them grow.

Thursday, July 9, 2015

Recapping FIA Law and Compliance 2015: Cyber Security, Bitcoin, Reporting and More

I recently attended the FIA Law and Compliance conference in Washington, DC. It was my first time joining our general counsel at this conference, and I thought I’d share some of my experiences there.

The conference allowed me to look at the issues and initiatives we are introducing at TT from a different angle: compliance with the exchange rules and industry regulations.

From MiFID II to the Volcker rule implementation, I was somewhat overwhelmed by the number of topics covered.

As a technology provider in the financial space, we usually are not impacted directly by the changing regulatory landscape; but seeing and hearing about the important issues that are on the plate of every market participant allows us to think about the things we can do better, or differently, to help our customers cope with the evolving rules.

Quite a few panels touched on cyber security and how to ensure that firms are protected from cyber threads. My favorite was the discussion with General Michael Hayden, a retired four-star general who previously served as director of the CIA and NSA. He discussed the topic with a lot of passion and color. The point he made as a conclusion was that it is up to us as a society to decide where we want to draw the line between how much privacy we are willing to give up versus how secure we would like to feel, and the governmental agencies will be able to execute based on that.