Out of hours trading: Not As Easy As It Looks
There is strong evidence that demand for out-of-hours trading is increasing, but if 24/5 trading is such a great idea, why isn’t everyone offering it? Michael Hall, Head of Distribution at pan-European securitised derivatives trading venue Spectrum Markets, shares his thoughts.
According to Acuiti, there is strong demand from investors to trade derivatives outside their local trading hours, and this demand is only increasing. The report certainly corresponds with our experience at Spectrum Markets, but it is interesting to look at what is driving demand for out-of-hours-trading and how this demand is being met?
The most striking findings of the study, aside from the fact that overall demand is rising, is that the majority of respondents to the survey said they are motivated by capturing specific opportunities and reacting to events at any time.
Not all investors are alike
However, the motivation changes slightly when looking at different types of investors. Retail traders associate seamless market access with convenience. Institutional market players responding to the survey highlighted the additional earnings potential attached to out-of-hours trading.
While portfolio managers may be seeking additional hedging opportunities, prop traders benefit from the optimisation potential of the longer trading hours.
Trading at all times of day and night enables investors to seize opportunities as and when they occur regardless of the relevant time zone, a highly sought-after feature for professional and retail traders alike.
But this is much less commonly available than one would think.
Easier said than done
The survey underpins Spectrum Market’s own positive experience with out-of-hours-trading, which consistently accounts for more than one third of its total trading volume. However, the question should be: if there is such pronounced demand, why are the offerings still so limited?
The main challenges are the need to have a trading infrastructure in place that is robust and resilient, alongside control mechanisms that are powerful and permanent.
Spectrum is open for trading from 23.00 CET on Sunday until 23.00 CET the following Friday, and each day’s trading session begins and ends at 23.00 CET. Throughout this schedule, immediate client support is provided at all times, and trading activity on the venue is monitored continuously surveilling for market abuse or any other incident that may need to be escalated for resolution.
All this is going on, without interruption, in the background.
The provision of sufficient liquidity is a core feature of a trading venue; if you’re not able to show competitive bid-ask spreads, you lose a key argument for on-venue trading over OTC trading.
When giving connected banks and brokers the option of making certain securities available on a 24-hour basis, it is essential to make sure liquidity is consistently provided throughout those extended trading hours. Otherwise, the tremendous effort required to enable round-the-clock trading would have been wasted, which is viewed as one of the most challenging tasks in continuous trading operations.
Facilitating liquid trading on a 24/5 basis requires market makers that are capable of supporting liquidity enduringly. Although modern market makers do not need to generate a profit from every trade, because the combination of bid-ask spreads and the bottom-line return from their overall trading activity is their profit, longer trading hours equate to increased risks that the market maker must cover.
Starting from scratch
By designing the venue from scratch, Spectrum had the chance to plan and scale its growth to accommodate the very specific needs of a retail trader client group, allowing Spectrum Markets to circumvent the concern of liquidity.
Starting with a focused product range has proved to be a huge advantage, particularly with a view to market making and even more so regarding periods of severe volatility. Every step towards a broader, more diversified offering requires intensive preparation and discussion with existing and potential partners before implementation.
Spectrum Market places a strong emphasis on an integrated approach regarding the product and transaction lifecycle. For example, Spectrum has enabled a high level of flexibility for its issuers to replace an expired product within minutes and introduced the pan-European ISIN.
Along with the obligations it imposes on their market makers, these measures are intended to ensure liquidity in sufficient depth, without interruption.
The future is bright
So, while demand is clearly there for longer trading hours, many trading venues, particularly those relying on legacy infrastructure, will struggle to accommodate this. But for the venues able and willing to innovate, the ever-evolving requirements of all sorts of investors provide an abundance of opportunities to stand out from the crowd.