Phones, Relationships Fuel Buy Side

NEW YORK—Buy side traders in equity derivatives still rely largely on contact with their brokers and telephones instead of the more cutting-edge trading options available, according to a new report from analyst firm The Tabb Group.

"The phone is and always will be a dominant order routing tool for derivatives," says report author and Tabb analyst Andy Nybo.

This is usually the case because buy-side equity derivatives traders do not have OMS-EMS connection or blotters with connection to their EMS, Nybo says. As a result, these traders turn to their brokers for advice and form a "very strong relationship," according to Nybo, who presented his preliminary findings at briefing last week in Manhattan.

Nybo surveyed 55 buy-side traders in late 2006 and early 2007 about their use of the equities derivatives market. Use of that market has grown eight fold since 1995, he says.

In futures, liquidity suffered after the contracts went electronic because "the liquidity in the pits helped" the traders, Nybo says.

Nonetheless, those in equity derivatives want better systems, more electronic trading, more efficiency and audit trails, Nybo says. "Dependency on the phone is the nature of derivatives, but as vendors" reach out to the market, they will develop better ways to trade, he says.

Until then, the "lack of technology reinforces the broker relationships," Nybo says. "It is critical for the derivatives traders." The average asset manager has about 19 brokers and those who develop relationships are willing to follow that broker if he or she moves to other companies, Nybo says.

Nybo says he expects that "reliance on the phone will slowly give way to greater implementation of technology solutions" like DMA and FIX, but "the broker relationship remains strong."

He finds that hedge funds, however, are already more technology savvy and rely more on the use of DMA and electronic systems and not on brokers as much.

Liquidity in the options space has improved, according to The Tabb Group. "There are parallels to the equities market with penny increments," Nybo says. The Tabb Group expects penny pricing to increase liquidity and grow derivatives action on the options side.