RSJ AS, the largest algorithmic trader on NYSE Euronext’s Liffe derivatives platform, plans to diversify into cash equities, bonds and interest-rate swaps as correlations between financial markets tighten.
RSJ’s goal is to start dealing in the classes in the first half of 2013, Bronislav Kandrik, head of trading, said in a telephone interview from the company’s headquarters in Prague. The firm, already active in stock derivatives such as futures and options, uses computers to make trading decisions.
“Our aim is to expand into new markets,” Kandrik said. “The economy affects all instruments. For a market maker, not to see a big change in one market can be dangerous.”
Founded in the Czech town of Pilsen in 1994, RSJ has used computer-trading technology to grow into one of the biggest market makers on London-based Liffe, CME Group Inc. in Chicago and Deutsche Boerse AG’s Eurex in Frankfurt. RSJ trades about 1 million lots a day in futures and other derivatives, Kandrik said. About 70 million futures and options contracts change hands daily on exchanges worldwide, according to the Futures Industry Association.
Computer-driven transactions and high-frequency trading have come under increased scrutiny after the so-called flash crash in May 2010, when the Dow Jones Industrial Average briefly lost almost 1,000 points. While high-frequency traders didn’t cause the rout, their habit of buying and selling rapidly led to the sudden removal of liquidity from futures markets, kicking off a related plunge in stocks, a report by the U.S. Securities and Exchange Commission and the Commodity Futures Trading Commission said in September 2010.
While some policy makers say HFT disadvantages smaller market participants and boosts volatility, Kandrik said electronic trading makes markets more efficient.
“It’s like robotic car building,” said Kandrik. “Before robotic car building, everything was built manually. Now we have a lot of robots helping and it has made the process more efficient and cheaper.”
European Central Bank Governing Council member Ewald Nowotny said on Sept. 13 that HFT is an example of financial innovation that can’t be controlled and should be banned. The European Parliament backed a range of curbs on the practice at a Sept. 26 vote, including a rule that orders must be kept in the market for at least half a second before they are canceled.
In the U.S., the SEC is also working to bolster regulations after Knight Capital Group Inc. suffered a $440 million trading loss on Aug. 1 that almost put the market marker out of business. Knight’s problems were a further setback for the infrastructure of an equity market still reeling from Facebook Inc.’s botched initial public offering and the failed IPO of Bats Global Markets Inc.
An algorithm shouldn’t be allowed to operate in market conditions which differ significantly from those for which its trading strategy was calibrated, RSJ’s Kandrik said. Computer-driven systems can be disabled during extreme events such as the flash crash, which briefly erased $862 billion from U.S. share values, he said.
“You can vary the level of engagement,” Kandrik said. “We traded through the flash crash. We adjust the behavior of our algorithms based on the situation in the market. There is always a human watching.”
The Chicago Board Options Exchange Standard & Poor’s 500 Implied Correlation Index climbed to 55.23 at 12:33 p.m. in New York yesterday, up from a four-year low on Oct. 18, according to data compiled by Bloomberg. U.S. stocks moved in unison last year by the most since at least 1980 as prices tumbled, according to data compiled by Birinyi Associates Inc.
Knight Capital, based in Jersey City, New Jersey, was forced to seek a $400 million cash infusion in August after a trading loss resulting from software that wasn’t properly installed. In March, Bats, the third-largest U.S. stock exchange owner, withdrew its IPO after the shares failed to begin trading on its own platform. The pricing of the first transaction following Facbeook’s $16 billion stock sale on May 17 took a half hour longer than Nasdaq OMX Group Inc.’s forecast.
The SEC in July voted to require exchanges and the Financial Industry Regulatory Authority to build a single system to monitor and analyze trading activity on U.S. equity and options markets. The rule mandates a so-called consolidated audit trail to expedite surveillance across 13 equity exchanges, 10 options markets and more than 200 broker-dealers that execute stock trades away from public venues.
It would be “very difficult” for regulators to vet the computer code used in the algorithms of all electronic trading firms operating in financial markets, Kandrik said. “Companies should explain their risk methodology and checks in as much detail as possible. We have always been transparent about this with our regulator and clearers.”