Algorithmic Trading

Trading options is not an easy concept to grasp at first glance. To most, trading with complete information that can be known ahead of time-known as the ‘efficient market hypothesis is almost impossible to pull off successfully.

Yet there are traders all over Asia, including in Hong Kong and Singapore, who have done just that for periods of years. These traders rely on algorithmic or mechanical methods to trade options with regularity.

Algorithmic trading has made its way into far more markets outside of the futures industry than ever before, thanks in part to some key developments in technology. Among these recent key developments includes more sophisticated algorithms, faster computers thanks to technological advances, and the ability to utilize faster data feeds.

These newer algorithmic trading strategies are known as ‘exotic’ options trading because they are less common. Many non-standard option structures are ruled by rules other than those governing the standard ‘vanilla’ options. Algorithms now make better use of all kinds of exotic derivatives, including digital options (binary), barrier options, lookback options and Asian options.

Asset pricing model categories

Asset pricing models can be divided into two categories: fundamental analysis and quantitative analysis.

The intrinsic value of an option is what the market believes would be required to induce holders of that option to enter into one or more other contracts (i.e., offsetting positions). The price paid for any derivative should equate only to the risk-neutral expectation of this optionality, which can be thought of as representing a particular type of ‘uncertainty’ about the future.

This implies that if there were no uncertainty, then no compensation would be made for holding this position; it would neither have a zero monetary value (the case with specific futures contracts), nor it would get repurchased immediately (for example, forward contracts and plain vanilla call options).

As such, the premium on an option should represent the degree of uncertainty related to the underlier’s price. This uncertainty is captured by a parameter referred to as the ‘volatility’ of the market.

The pros and cons of Asian options

Compared to European-style contracts, which can only be exercised on their expiration date, an Asian option might allow the holder to take a long or short position between two predetermined dates set at the beginning of the contract. This is most commonly known as a “lookback” feature. This feature allows manufacturers to hedge differentials in commodity prices over time.

The major difference between European and American styles is that holders of American style contracts may exercise them at any time during the life of the trade rather than just on specific dates based on conditions specified by both parties during contract negotiation. Like their European counterparts, American options are typically traded over the counter.

Asian options are, on average, more expensive than vanilla options of the same type. The payoff structure of Asian options is more complex, and they usually are less liquid than the vanilla version of the same underlying instrument.

Asian options are typically written on Asian or exotic underlying instruments, including indices or baskets of stocks not represented in the main market indices. Since they are less common, compared to vanilla options where there is better liquidity due to its high volume, Asian option trades are often made over-the-counter directly between two parties, whereas vanilla options deal with full-service brokers who act as dealers and make two-way prices or bid/ask spreads available to other market participants.

If you buy an American style contract, these spreads could be more comprehensive since it would be possible for your broker to offset his position with another counterparty if he anticipates a substantial movement in the underlying stock’s price and doesn’t want to risk being on the wrong side of a market move.

Finally

Trading listed options in Asia can be exciting and financially rewarding if done right. New traders are advised to use an experienced online broker from Saxo bank. For more information, look at this site and start your investment journey today.