Buy-Side Options Trading: Covering the Spread in Complex Order Books with Multi-Leg Strategies

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22 September 2015

As multi-leg options strategies gain traction on the buy- and sell-side, sophisticated front-end tools are essential for accessing complex order books at US options exchanges.

Multi-leg orders have been around a long time, but in recent years they have moved from the trading floors to electronic systems.

A complex order (or spread trade) allows an options trader to simultaneously buy and/or sell a number of different options that in the past would have required placing separate electronic orders. These complex orders are made up of at least two legs and are priced as a package.

Over the past decade, complex order books at US options exchanges have seen their volumes surge and account for close to 40 percent of the trading volume.  In this environment, one of the challenges for traders is that liquidity has become fragmented across complex order books at these exchanges.

Seven US options exchanges, including Chicago Board Options Exchange (CBOE), International Securities Exchange (ISE),C2, NYSE Arca, NYSE AMEX, Nasdaq PHLX and BOX, operate complex order books.  Each of these exchanges has its own complex order book, and is willing to provide that information to traders who subscribe to their feeds. However, exchanges don’t provide access to the other complex order books.


To address this issue, FlexTrade offers Derivix-AM (for the buy-side) and Derivix-SM (for the sell-side), a best-of-breed derivatives order/execution management system (OEMS) that combines FlexTrade’s EMS with Derivix’ time tested functionality in portfolio risk management and scenario analysis. With Derivix, traders can search all the exchanges and aggregate the total of all of their complex orders. When someone posts a spread order on a specific exchange, traders require access to the complex order book feeds. Without a tool such as Derivix, traders won’t have visibility into the complex order books.

Scanning Complex Order Books

When trading spread orders it’s very important that traders scan all the exchanges to see what orders are out there, to know if and where there is liquidity, and to know if someone is a penny away from what they want to do. Typically, traders will post their complex orders on multiple exchanges.

With Derivix, traders can scan the complex order books and filter the results. For example, they could scan the complex order data for a specific underlying, expiration and moneyness. Derivix solves the problem of fragmentation by aggregating the results of its searches across all complex order books.

Visibility Challenge

As buy-side traders take more control of their executions, fragmented liquidity is driving demand for algorithms to manage the complexity of these options strategies.

As an options EMS, Derivix offers pricing and analytics, algorithms, smart order routing and scanning of order books. To execute multi-leg orders, Derivix provides two complex order algorithms. The most popular, called the Flex Multi-Leg Algo, is a liquidity-removing algorithm that looks at the legs of the spread, and if they line up with the market, goes out and grabs all the liquidity available for each leg of that spread.

Algo Advantage

  1. The Flex Multi-Leg Algo allows the trader to split a large order and route among multiple destinations. For example, if a trader has an order for 10,000 spreads, he might send 3,000 to the CBOE’s COB, 4,000 to ISE’s Spread Book and dribble out the remaining 3,000 across the other complex order destinations. Or, the trader may send 30% to CBOE, 30% to ISE and work the remaining 40% through an algorithm.  (Many of the other EMS providers lack the ability to break up a complex order into three parts and send to two or more user defined destinations.)
  1. The second complex order book algorithm is called Single-Leg-Driver, which allows one leg of the spread to drive the other legs of the options trade. Single-Leg-Driver will give the user the ability to post one leg inside the market as long as they can get the other leg executed at the market. The idea is that a trader may be willing to give up some edge to get the order completed.

Connecting and Routing to Options Exchanges

Following are the key features and extensive capabilities of Derivix that relate to complex order books:

  1. Derivix routes complex orders of up to 10 legs across multiple venues.
  1. The platform can use implied or derived orders in the marketplace to potentially fish for a better price.  For example, if someone is working a large spread at a price that is a couple of cents from marketability, the system is able to place an implied order between the bid and ask market of one leg contingent upon posted market prices and sizes existing for the other legs.  The posted order adjusts price and size in real time relative to the market prices and sizes for the related legs. This is like fishing for liquidity as a trader drops a lure into the market at an enticing price near fair value which, if hit, will trigger trades for the other legs as well.
  1. Derivix can support both direct exchange connections as well as direct connections to brokers.
  1. When firms utilize the Flex Multi-Leg Algo on Derivix to send their orders direct to complex order books, they can take advantage of FlexTrade’s speed to obtain a better price. This method is a way to seek a better price or a faster fill than just sending multi-leg orders to the exchanges to go through an auction with the complex order book.

Spread Trading is the Future

Despite the complexity of valuing and trading complex orders, they are popular with retail and institutional investors. This is really where the market is headed.

In the end, traders are trying to leg spreads, so if FlexTrade makes it more efficient for them with smart algos and a cutting edge front-end, it definitely seems like the future.