Algos in Futures Markets: Shifting into High Gear

Futures algorithms provided by futures commission merchants (FCMs) and facilitated through front-end trading systems are beginning to mature. Current users have new demands to support existing practices and are looking to further build out their advanced execution strategies. At the same time, a number of large buy side institutions, including those that have traditionally shied away from using futures algos, are showing interest, with a rising number of requests being received by algo providers.

As providers continue to build out their electronic offerings, the development and use of futures algos are shifting into high gear. Futures markets offer a rich environment for algos due to product diversity, margin efficiencies, and cross-market appeal. Greater demand for algos is a direct result of the market’s growth, with more complex strategies and the need to automate processes prime factors driving adoption. For optimal results, firms must use automation to improve trading desk efficiencies, lower execution risks, and better compete with market participants already using and upgrading their advanced execution strategies.

Meanwhile, the sell-side is happy to accommodate, believing its expertise around building and developing front office technology can effectively cater to institutional needs. Brokers and banks focused on specific asset classes and truly understanding what clients want will have a better chance of appealing to market participants looking for a total package. As client demands evolve, FCM innovation will depend on this relationship.

While some brokers have taken the algorithms they created for the equity markets and replicated those same strategies in the futures markets, others have built a futures-specific suite. A so-called best-in-class strategy is a differentiator, but that is becoming more common and so providers are facing a dilemma. Too sophisticated of an algorithm offering can scare users away while too few dials as part of the strategy can appear too simplistic.

Today, there are also new rules to consider whereby brokers that develop their own algos must consider their decision to be involved in the electronic trading business. With algo development more complicated and expensive, the tangential benefits of providing automation tools to clients must emerge clearly over time or the investment becomes a losing proposition. In this regard, larger FCMs are in a better position to support the necessary scale and all the operational support required under a more holistic client relationship.

The next phase of algorithm development will include smarter ways to trade and work through investment and trading decisions. Many long-only firms will continue to use futures algorithms primarily to hedge positions but will begin to experiment with using futures algorithms to gain alpha. These firms will require tools that not only help put money to work but also mitigate trading risks across the risk profiles of different markets.