How is Program Trading Changing?
April 21, 2011Sophisticated equity traders have been watching program trading activity for years. Keeping an eye on the premium (PREM) or spread between the most active S&P 500 future’s contract fair value minus the cash value is a time honored tradition to determine when stock buy or sell programs should kick into gear. While this tactic has proven itself as a smart way to get an edge in the market, just what is program trading and how is it changing within the trading landscape?
Program trading is generally defined as trading a basket/portfolio of 15 or more different stocks with a combined value of at least $1 million. This form of trading is primarily used by institutions and was spawned by the rapid growth in Electronic Communication Networks or ECN’s. A recent survey has revealed that program trading volumes have increased more than 50% over the last year.
Interestingly, despite the volume increase, program trading has taken a back seat to more sexy strategies such as HFT and dark pools in the financial press. This can be a good thing for the program trading firms as their bread and butter operations are under the radar of media scrutiny unlike their brethren. What is causing this increase in program trading volume? The cause is three fold, technological improvements, the market itself, and strategic changes. Let’s take a closer look at each of these program trading volume drivers.
- First, changes in the market itself have driven greater volume toward program trading strategies. Mike Lawksy, Head of UBS US Program Trading Sales told Traders Magazine, “Volatility was light for much of 2010. In addition, the market correlation was higher, meaning that many stocks or sectors tended to move more often in tandem. In such an environment, index-based and ETF investing in equities made more sense to risk-averse investors seeking to increase market exposure. In addition to the flows into index funds, allocations to international strategies and small-cap strategies have been growing. This is another area where a primary coverage spot is often the program trading desk. The flow of money into those strategies over the past 18 months has been supportive of that growth in program trading flow.”
- Secondly, technological improvements in both tools used to execute program trades and the algorithms themselves have undergone a positive evolution. More sophisticated and easier to use program trading platforms have drawn additional sell and buy side traders into the lucrative field. The new tools allow traders to combine smaller portfolios that increase the volume of program trading. Advances in algorithms allow traders to balance different and exotic stock baskets that were impossible to calculate earlier. In addition traders have the capacity of adjusting the basket as a whole instead of each individual holding.
- Last but far from least, strategic and tactical changes have attracted volume to program trading. Institutions have started to shift to more passive investing strategies that open up greater opportunities for program traders.
Over the next year and further, program trading is very likely going to continue to grow in popularity and volume. Long term trend changes in the marketplace make this practically a given.
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