Pipeline Acquires 3D Markets for Block Options Crossing
Pipeline Financial Group, operator of the Pipeline block execution systems, acquired the assets of 3D Markets, Inc. known for developing the first block options execution system. Financial terms of the transaction were not disclosed.
The acquisition moves Pipeline into a new asset class, equity options, which is a derivative that is based upon the underlying stocks held by its institutional clients.
“By acquiring 3D they’re getting access to a crossing mechanism developed specifically to address the challenge of trading block options anonymously,” commented Andy Nybo, principal and head of TABB Group’s Derivatives Practice in an interview with Advanced Trading this morning. Through this acquisition, Pipeline is entering into options, which has been a fast growing and dynamic industry over the past five years, said Nybo. “It gives them a foothold, they can jumpstart their efforts in that space, they can offer both underlying equities and option to their client base,” he said.
Based in New Hope, Penn., 3D Markets, headed by founder and CEO David Mortimer, a pioneer in algorithmic trading at Vie Systems and then at Piper Jaffray, launched an options crossing platform in February of 2008.
“We’re interested because we know that our clients are telling us that they are beginning to use options in ways other than just selling calls to generate income,” says Alfred Berkeley, Pipeline’s chairman in an interview with Advanced Trading this morning. While many mutual funds have been selling calls for a long time, some institutional clients are using more sophisticated strategies and using them as a substitute for long positions, says Berkeley. “We wanted to understand the interactions of the equity markets and the equity options markets,” says Berkeley.
But as institutions look to hedge their underlying stock positions or use option to better hedge their risk, Nybo said, “One of the challenges they face is executing in size, getting their block trades done.”
In the same way that Pipeline’s wholesale block trading system provides a mechanism on the equity side for protecting institutions from information leakage or the switching engine goes out to traditional markets with technology that obscures the order from pattern recognition software, or sends out encrypted messages via its blotter liquidity model (rather than scrape the blotter), 3D Markets’ software is also protecting the institutional equity and options orders, said Berkeley.
“What David Mortimer is doing is different. He’s creating the same level of ambiguity and cover that we’re providing (in stocks), but he’s extending to the liquidity provider the volatility characteristics of the shares he wants to get options on without giving the underlying identity of the stocks,” explained Berkeley.
According to Mortimer, 3D was always directed towards the growth of the use of options by traditional asset managers, specifically, an institutional investor with $1 billion in assets. Since Pipeline is reaching all the equity managers, those are the same folks that are beginning to trade options more and more. But an asset manager of that size, would have one million to three millions shares in any given name, which name they’d need 20,000-to-30,000 contracts. “Those are block options. They have not had an effective way to trade that today,” says Mortimer. “The market is well aware whoever buys that 30,000 contracts is going to have to hedge themselves in the equities,’ said Mortimer. “That is where the front-running occurs,” he added.
Mortimer said when he considered selling the company he pursued it with the idea of finding a partner with the best distribution network and best reputation. “We ended up with Pipeline and those were our two key considerations,” he said. Pipeline can offer 3D a big universe of buy-side clients immediately, said Mortimer.
In terms of software assets, Pipeline is acquiring the Archangel Blind-Bid Cross, a system that matches liquidity providers with institutional investors, without divulging information about the underlying stocks.
In addition, 3D Markets also offers an Archangel Benchmark Cross, which is based on Gamma Volume Weighted Average Cross or GWAP, through a relationship with the CBOE, which will be transferred to Pipeline. Similar to what ITG and Instinet do on the equity side, 3D is trying to bring VWAP to options. “It’s a pre-opening cross that is essentially a facility of the CBOE and once the cross is finished — it’s basically a window opened for a half hour — orders are entered and matched. Then at the end of the day, the GWAP is calculated.
Pipeline will need to integrate the platforms but initially, the first integration will occur via the desktop though Pipelines GUI (graphical user interface). While the addition of 3D Markets will be a differentiator for Pipeline, Berkeley acknowledges that there is going to be a learning curve. “It’s not like options trading is going to burst full bloom onto customers’ desks. But "there will be a few early adopters," says Berkeley, also noting that 3D has some high quality, large institutions committed to its platform.
Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio