New Off-Exchange System will Focus on Block Options and Complex Strategies, Pending Regulatory Approval By Ivy Schmerken April 21, 2008 In a move to aggregate liquidity in the fragmented options market, Ballista, a start-up broker-dealer, is announcing today the first equity options liquidity pool that will provide electronic access to public and non-public liquidity from banks, hedge funds and market makers. Pending regulatory approval from FINRA to register as a broker-dealer, Ballista will launch the new electronic platform focusing on block options and complex strategies like delta neutral trades, as early as May 2008. Today, April 21st, Ballista is going into beta testing with light trading to test the system and make sure the business logic and functionality works. In a statement, Robert Newhouse CEO of Ballista cites the phenomenal growth of the options industry. "However, the expansion of new market participants and exchanges, as well as the introduction of new regulations such as the penny pilot, have led to a highly fragmented marketplace, " warned Newhouse in the release. Ballista was formed in the past year to solve the problem of fragmentation in the options market. "We're trying to aggregate active liquidity that exists on an exchange as well as the passive liquidity that is not listed anywhere but exists in the mind of a trader," says Newhouse in an interview with Advanced Trading. Today, the passive liquidity must go through a floor broker. If a hedge fund calls a broker, a market maker will take the other side of the trade. "But there is no way to currently advertise an order to the market maker and have them respond," says Newhouse. Ballista has developed an electronic trading platform that ties together equity and options trades without the need for intermediaries such as floor brokers. "The idea is a single electronic platform that can scrape liquidity from the public markets while accessing passive liquidity from hedge funds, broker dealers and trading desks," says Newhouse, an industry veteran who has held management roles in technology design, engineering and platform implementation at Island ECN, ABN AMRO, TORC Financial and Orbit II Partners. In addition, Ballista is sourcing liquidity from public exchanges, leveraging the dark pools for equity trades, and it's tapping the complex order books at the ISE and CBOE. "We aggregate liquidity from stock exchanges and complex order books. Our system will look into the options exchanges and equity exchanges and when both components are in line, we will trade both as a set," says Newhouse referring to delta neutral trades. However, Ballista will never post an order. "We never want to advertise to the world. Everything we send is an immediate or cancel to the public market," says Newhouse. Ballista is targeting over $1 billion in available commissions from participants that execute delta neutral trades, which Newhouse calls "a niche market but a fairly large one." In a delta neutral trade, there are two or three options legs tied to a stock at a pre-defined price and delta of a stock. The delta implies the quantity of stock that will trade in a ratio to the option. "If the delta is defined as 100, that means for every option on that underlying stock, "I'm going to trade 100 shares of that stock," explains Newhouse. As a liquidity pool for block options trades, Ballista will seek to match orders against one another. "The idea of sweeping the public markets is an ancillary part of the system," says Newhouse. In a block option transaction where there is no stock involved in the trade, Ballista is confined to execute within the options national best bid or offer (NBBO). However, if someone is doing a delta-neutral trade, "We are able to reprice the option and stock component. The stock can print outside the NBBO," says Newhouse. Ballista is using the SIFMA 611 exemption, which defines the fact that it is able to trade the stock outside the NBBO as long as its tied to an option-contingent trade, says Newouse. SIFMA initiated the request for an exemption and was granted the exemption last year. Ballista will seek to bring together initiators such banks and hedge funds seeking liquidity and contras who are providing liquidity or trading against those initiating orders, says Newhouse. (Ballista will screen participants based on creditworthiness, size, trade volume and frequency of participation in the initiator vs. contra role.) Broker dealers often seek liquidity on behalf of their customers, but they're also providing liquidity to that delta neutral trade, he says. The system will provide a FIX-based interface supporting programmatic orders from algorithmic trading desks and electronic market making desks. (However, Ballista doesn't want to be in the front-end business, Newhouse says. He'd much prefer that participants use their order management systems (OMSs) and DMA platforms connect to the platform via a FIX gateway. Currently, the initiating side of the order has to use an intermediary to gain access to these sources, says Newhouse. The buy-side makes a phone call or sends an instant message or may have to interact with an inter-dealer broker or an agency broker desk or call a floor broker, or uses one of the thousands of DMA platforms (such as REDIPlus or TradeFeed) that exist, says Newhouse. "It's a very inefficient workflow with higher level of costs because I have to deal with multiple intermediaries that charge higher fees because this is manual (intervention)," says Newhouse. "Instead of doing a trade within seconds or minutes, my trades may take half an hour," says Newhouse. Instead, Ballista has designed a "reactive option process where someone initiates an order and that order is advertised to certain people and people trade against that order," says Newhouse. If an initiator enters an order for 120 options contracts on Microsoft, the contra can see the order come in and advertise to them proactively. Once an order is posted, there is a timed auction process in Ballista that lasts five minutes. Other parties on the system using the Ballista front-end may trade against the order. If the open auction process doesn't result in a complete execution, then Ballista takes the initiator with any remaining liquidity it has, and places it into a one-to-one price and size negotiation with the top contra, where their anonymity is maintained. Reg ATS for Options? However, there are some hurdles to operating an off-exchange trading system in options. Because there is no "Reg ATS" in the options world, every options trade has to be brought to the exchange. Even if Ballista has two parties willing to do a trade, it must present that to an exchange with a cross mechanism. Since Ballista is trading 500 contracts and larger block orders, it plans to submit the cross with an all-or-none type of order. That means "if the crowd wants to partake and step in front of the order, we're now forcing them to take all of it â they have to step in on the entire 500 block and they have to price improve it by one tick," says Newhouse. "We're using all-or-none which means statistically, the crowd won't be stepping in," says Newhouse. While Ballista must comply with this regulation of presenting the trades to the exchange, Newhouse is hoping to bring large amounts of market maker liquidity into the platform. "The idea is to bring their liquidity into the platform before you submit the cross to the exchange," says Newhouse. Ballista's CEO admits the rules are not ideal for an off-exchange options trading system. But he says it's only a matter of time before something similar to Reg ATS comes to the options world.