Dark pools are creating waves in the equities market. Vishala Sri-Pathma looks at whether they can transform equity options trading
The FOW switchboard has been inundated with calls from
numerous institutions after word spread that we were explaining
the issues around dark pools. It seems to have caused quite a
stir, particularly with talk of dark pools entering the options
arena. But what are they and how can they be applied in the
futures or options markets?
A textbook definition would be "hidden pools of liquidity
which are not visible other than via electronic means, enabling
the free movement of large numbers of shares, without revealing
identity to the open market". In other words, they are crossing
networks that provide two services critical to the
institutional investor – anonymity and liquidity. They
allow participants to buy anonymously or sell large blocks of
securities, without using listed stock exchanges or impacting
publicly quoted prices on those exchanges.
Dark pools of liquidity have been buzzing about in the
equities market for some time and have appeared to bring
significant value to the market. The increasing number of
venues where trades are executed has fragmented the market and
with the entrance of new forms of electronic trading such as
algorithms, what traders demand of the market has become very
Sigma X claims to offer "the largest pool of non-displayed
liquidity in the United States", while BATS Trading has taken
the lead on aggressively reducing trading costs year after
Merrill Lynch and ITG’s joint offering,
Block-Alert, allows institutional investors access to a large
standing pool of liquidity, capable of absorbing buy or sell
orders without matching. Crossing networks account for more
than 10% of all equity market trading, with business growing
about 40% per annum. Considering the vast sums of money
attracted to dark pools of liquidity in the equity market,
their numbers are certain to continue growing.
As dark pools grow and converge, they are beginning to
compete for business with traditional exchanges such as NYSE
Euronext. BATS has already applied to the Securities and
Exchange Commission for registration as a national securities
exchange, an action that existing organized exchanges are
watching closely with a sense of suspicion. One of
BATS’s competitors, DirectEdge, has indicated it
also intends applying for exchange status.
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