Trading and information in futures markets

This paper studies the trading behavior of different types of traders (customer type indicators [CTI's]) in corn futures. Nonmembers (CTI4) consume most of the intraday liquidity while local traders (CTI1) as market makers are its main provider. Both groups combine most of the intraday trading volume. Interday trading comes mainly from proprietary accounts (CTI2) and other local traders' trades (CTI3), reflecting their longer-term needs for hedging and speculation. Changes in the overnight positions of the general public (CTI4) and clearing members (CTI2) contribute mostly to daily price discovery, while the positions of CTI3 group reflect possible information advantage about future price movements.     

Small traders in currency futures markets

This study examines the interrelation between small traders' open interest and large hedging and speculation in the Canadian dollar, Swiss franc, British pound, and Japanese yen futures markets. The results, based on Granger‐causality tests and vector autoregressive models, suggest that small traders' open interest is closely related to large speculators' open interest. Small traders and speculators tend to herd, which means that small traders are long [short] when speculators are long [short] as well. Moreover, small traders and speculators are positive feedback traders whereas hedgers are contrarians. Regarding information flows, speculators lead small traders in three of the four currency futures markets. The results therefore suggest that small traders are small speculators who follow the large speculators, indicating that they are less well informed than the large speculators. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark 31:898–913, 2011     

Electronic Call Market for Commodity Transactions: Design of Computer-Mediated Order Matching System

Commodity exchanges provide potential market structures for electronic trading because commodity products have relatively simple and well-standardized product attributes. Most existing electronic trading systems are introduced for financial exchanges, where qualities of traded products (such as stocks and bonds) are homogeneous, thus taking into account only bid and offer prices for computer-mediated order matching. However, a single commodity market, such as the cotton or grain market, is made up of many heterogeneous goods that are similar to each other but have different product qualities and contract terms. In addition to the price, commodity traders have other pertinent preference ranges over product attributes and delivery conditions. We delineate an electronic call market system for commodity trading, which optimizes the realization of traders' utilities over extended product attributes beyond the price. The electronic call market not only maximizes the total surplus of market participants based on bid and ask prices but also satisfies their qualitative preferences over other attributes, which are difficult to include in the quantitative prices. The trading mechanism of the electronic call market integrates an economic auction model with a social choice model to produce a Pareto-improved transaction. Market simulations are conducted to validate the performance of the proposed electronic call market. The order matching system of the electronic call market is implemented using constraint logic programming.     

Volatility trade design

Despite the fact that they are heavily traded, discussed in every derivatives text, and necessary to aligning implied volatilities with volatility expectations, volatility trades such as straddles, strangles, and option/asset combinations have received scant attention in the finance research literature. Using a unique data set for the Eurodollar options market, the trading and structure of seven volatility trades—straddles, strangles, option/asset combinations, guts, butterflies, iron butterflies, and condors—are examined. We find that both traders' choices among the seven strategies and the designs they choose for the individual strategies indicate that volatility traders seek designs with (1) low deltas, (2) low transaction costs, and (3) high gammas and vegas. Among other things, these three presumed objectives explain why butterflies, guts, and condors are rarely traded; covered call and put writing is rare; and straddles are the most popular volatility trade. These objectives also explain the usual design of straddles, strangles, and asset/option combinations and the straddle–strangle choice. Our data also indicate that, in constructing their spreads, traders rely on heuristics that lead to relatively low deltas and high gammas and vegas, but not always the lowest delta and highest gamma/vega constructions implied by more sophisticated models. We find little evidence of trading based on the shape of the smile, that is, little evidence that trades are designed to long (short) strikes with low (high) implied volatilities. We find that some volatility trade structures—those that (1) receive considerable attention in finance textbooks, (2) have been posited by finance researchers, or (3) are recognized by the exchanges—are rarely employed by traders, whereas others are quite common. © 2005 Wiley Periodicals, Inc. Jrl Fut Mark 25:243–279, 2005     

Trader networks and options risk management

We examine the effect of trading partner concentration and a matrix of variables which dictate the relative importance of a trader to the network on a set of large member proprietary traders’ risk. An increased closeness centrality and concentration of trading among network partners are found to reduce price, volatility and rebalancing risk. We further explore the nature of trading concentration established through traders’ recurring trading relationships to find that trading with an established and small network has a positive, yet costly, effect on inventory management. Relationships among market makers are important to managing their portfolio of risk.     

The interaction between foreigners' trading and emerging stock returns: Evidence from Turkey

Using monthly foreign flows data on Istanbul Stock Exchange (ISE) and employing a structural VAR model, we analyze the interaction between foreigners' trading and emerging stock returns. In contrast to most of the available theory and repeated previous findings on other markets, foreign investors negative-feedback-trade with respect to past local returns in ISE, however only in rising markets and especially under macroeconomic instability. Net foreign flows forecast future market returns, but not individual stock returns. Price impacts are permanent, suggesting that foreigners' trading incorporates information. Overall, results reject previous conclusions that foreigners are uninformed positive feedback traders: rather, they are a heterogeneous group dominated by sophisticated investors able to rationally adjust their trading style in line with the market's prevailing characteristics.     

Price Discovery in the Pits: The Role of Market Makers on the CBOT and the Sydney Futures Exchange

This paper uses the methods of error correction and common factor analysis to estimate the contribution of locals (market makers who may participate directly by trading for their own account) and non‐local traders to price discovery on the floor of the Chicago Board of Trade (CBOT) and the Sydney Futures Exchange (SFE) during a period when open outcry trading was used on both exchanges. We examine these two execution channels for the CBOT's U.S. Treasury bond contract and the SFE's three‐year bonds, ten‐year bonds, ninety‐day bankers' accepted bills, and stock index contracts. For each of the futures contracts, the trade price series of local and non‐local traders are cointegrated. VAR analysis reveals lag structures eight to fifteen trades long in the dynamic adjustment of equilibrium prices in these markets, but time spans of only one to three seconds within synchronous trades. We find evidence of multilateral price discovery by the two execution channels for each of the five contracts. Locals account for 44 to 73% of the price discovery in the four SFE contracts and for 58% of the price discovery in the CBOT's T‐bond contract. © 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:785–804, 2004     

Is it Efficient to Impose Costs on Small-Volume Equity Traders?

A securities market that imposes higher trading costs on small-volume traders may reduce free-riding on information generated by large-volume traders. The reduction in free-riding increases the probability that large-volume traders will invest in socially beneficial information and engage in costly monitoring of managers of firms in their portfolio.V arious mechanisms can be used to impose costs on small-volume traders.We argue that Nasdaq's former treatment of limit orders was one such mechanism. Depending on the market's structure and the nature of the securities traded in the market, a reduction in freeriding activity may improve overall market efficiency despite a potentially negative impact on information dissemination.     

The impact of net buying pressure on index options prices

This study examines whether the demand for options, as measured by the net buying pressure of index options, explains the implied volatility structure created by options prices. We decompose the buying pressure into the direction‐motivated (i.e., delta‐informed) and the volatility‐motivated (i.e., vega‐informed) demand for options. After controlling for options traders' hedging demand, we find that both delta‐ and vega‐informed trading play significant roles in explaining changes in implied volatility. Foreign institutions are more directionally informed in index options trading than their domestic counterparts are. Domestic investors effectively implement volatility trading using put options.     

Local trader profitability in futures markets: Liquidity and position taking profits

This study examines the profitability of local traders on floor‐traded futures markets. Using unique data from the period of floor trading on the Sydney Futures Exchange, local income is decomposed into liquidity and position‐taking profit components. Locals on the trading floor are found to make significant position‐taking profits. Moreover, the ability of locals on the floor to derive position‐taking profits is positively related to order‐flow related information, and negatively related to the presence of exogenous information, local liquidity profits and the length of a locals inventory cycle. Accordingly, this paper characterizes locals as active informed traders. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 30:1–24, 2010     

The double-edged impact of social media on online trading: Opportunities,threats, and recommendations for organizations

While we understand well how social media channels sway consumers, there is little understanding of their influence on online trading behavior. We argue that social media are creating a new class of self-directed online traders by simultaneously encouraging and biasing trading decisions. Through an empirical study, we show that heavy social media users are more likely to engage in online trading but are largely affected by online herding behavior, and are four times more likely to blindly follow other traders. Bloggers, influencers, social network contacts, and social media news shape these users’ online trading behaviors. As online traders influenced by social media are unlikely to receive adequate returns, companies face an ethical dilemma: They could leverage social media to efficiently access funds but they risk inappropriately exploiting the inexperience of online traders biased by social media. We offer a set of nine practical recommendations for organizations to respond to these new challenges.     

How Different Types of Traders Behave in the Taiwan Futures Market

This paper examines the heterogeneity of the disposition effect and its impact on profitability among three different types of traders, using complete trading data from Taiwan's futures market. More than 70% of the trading volume on this market comes from retail traders (RTs), with an additional 15% from foreign institutional traders (FIs) and proprietary traders (PTs). Both FIs and RTs exhibit the disposition effect whereas PTs do not, and FIs with a weaker disposition effect outperform RTs. This study provides evidence that RTs with the disposition effect tend to lessen the effect in the next period, exhibiting the phenomenon of mean reversion. While previous studies focus only on the static relationship between the disposition effect and profitability, ours explores the dynamic rather than the static behavior of RTs, providing a more complete and objective idea of their trading behavior. In addition, the positive relationship between the current disposition effect and prior profits suggests that the degree of the disposition effect increases when RTs have prior profits. © 2012 Wiley Periodicals, Inc. Jrl Fut Mark 33:1097–1117, 2013     

Trader Survival: Evidence from the Energy Futures Markets

This study analyzes the adaptation of traders and the determinants of trader survival during a period of changing market structures. Our unique sample of transactions level data covers the introduction of electronic trading in the NYMEX energy futures market. The results show that most floor traders adapted to the side‐by‐side electronic and open outcry trading, although trader attrition increased and the profitability of surviving traders declined dramatically. It is also found that trading profits, trader experience and sophistication, and dual trading have a positive effect on the probability of trader survival. Scalpers are less likely to exit trading in pure open outcry trading, but are more likely to fail than traders who hold open positions longer in side‐by‐side trading. Finally, traders trading in multiple energy futures markets and those who use both the exchange floor and electronic trading appear to have a survival advantage in side‐by‐side trading. © 2011 Wiley Periodicals, Inc. Jrl Fut Mark 32:809–836, 2012     

Margin requirements and futures activity: Evidence from the soybean and corn markets

This article investigates the impact of margin requirements on the trading activity and volatility in futures markets. We extend Hartzmark's (1986) model for futures demand to allow for the costs imposed by margins to change across the maturity of the contract. The model is tested employing data from the soybean and corn markets. We find that trading activity becomes more sensitive to margin changes as one gets closer to contract maturity, inconsistent with the notion that margins impose important opportunity costs on futures traders. Margins are found to have a negative impact on the trading activities of all types of traders, though there is some evidence that margin alterations bring about changes in the makeup of the market. The data also indicate that margins are likely to be hiked during periods of increased volatility, and reduced during periods of relative stability, thus suggesting that margin alterations serve primarily as insurance to futures exchanges. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 433–455, 1999     

When is informed trading more prevalent?—An examination of options trading around Indian M&A announcements

This study examines the prevalence of informed trading around proximate-date versus far-date mergers and acquisitions (M&As). Further, different options strategies pursued by informed traders in proximate-date M&As are identified. The results highlight that proximate-date M&As are associated with a significantly higher level of informed trading vis-à-vis far-date M&As. Results on the choice of options strategies highlight that risk-averse, informed traders may pursue a straddle strategy to profit from their private information, while risk-seeking, informed traders may use a vertical call spread strategy. Informed traders desirous of hedging their existing positions may employ a protective put strategy.     

Order imbalances and market efficiency: New evidence from the Chinese stock market

This paper differentiates order imbalances based on trader categories. The daily order imbalances are highly persistent, especially for the number-measured imbalances. That the price pressure caused by imbalances cannot last beyond a trading day indicates that China's stock market is efficient enough to absorb the imbalances. We find that large individuals, small individuals and small institutions act frequently as market makers by submitting non-marketable limit orders, and the market making activities are profitable for small individuals and institutions. The evidence indicates that individuals are noise or liquidity traders, while institutions are more likely to be informed traders.     

India's Informal Trade with Bangladesh: A Qualitative Assessment

The large and vibrant informal trade between India, and Bangladesh continues to thrive despite unilateral/regional/multilateral trade liberalisation in these two countries. This calls for an in-depth analysis of India's informal trade with Bangladesh. Using insights from the New Institutional Economics informal and formal institutions engaged in cross-border trade are contrasted to examine whether informal trading arrangements provide better institutional solutions. The analysis, carried out on the basis of an extensive survey conducted in India and Bangladesh reveals that informal traders in India and Bangladesh have developed efficient mechanisms for contract enforcement, information flows, risk sharing and risk mitigation. Further, informal traders prefer to trade through the informal channel because the transaction costs of trading in the informal channel are significantly lower than the formal channel implying that informal trade takes place due to the inefficient institutional set up in the formal channel. The principal policy implication from the study is that unless the transacting environment of formal traders improves, informal trade will continue to coexist with formal trade, even if free trade is established in the SAARC region.     

Intraday Liquidity Provision by Trader Types in a Limit Order Market: Evidence from Taiwan Index Futures

This study examines the dynamic liquidity provision process by institutional and individual traders in the Taiwan index futures market, which is a pure limit order market. The empirical analysis obtains several interesting empirical results. We find that trader type affects liquidity provision in a number of interesting ways. First, although institutional traders use more limit orders than market orders, foreign institution (individual) traders use a relatively higher percentage of market (limit) orders in the early trading session and then switch to more limit (market) orders for the remainder of the day until close to the end of the trading day. Second, net limit order submissions by both institutional and individual traders are positively related to one‐period lagged transitory volatility and negatively related to informational volatility. Third, net limit order submissions by institutional traders are positively related to one‐period lagged spread. Finally, both the state of limit order book and order size significantly influence all types of traders’ strategy on submission of limit order versus market order during the intraday trading session. © 2012 Wiley Periodicals, Inc. Jrl Fut Mark 34:145–172, 2014     

Information and Noise in U.K. Futures Markets

This paper examines the extent to which futures price changes are driven by noise and information for three U.K. futures contracts by utilizing T. Andersen's (1996) specification of the mixture of distributions hypothesis. Use of the generalized method of moments approach demonstrates that the link between futures volume and volatility can be attributed to the flow of information. More importantly, it is shown that price movements are dominated by informed rather than noise trading for the FTSE‐100, the Long Gilt, and the Brent Oil futures contracts. The results suggest that further regulation based on the notion that noise traders dominate futures trading is unwarranted. © 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:711–731, 2004     

Interdealer trading in futures markets

Trading amongst dealers on the floor of the futures exchange is examined. Since there is only one trading venue, the common floor area, trading between dealers is carried on in the presence of trades involving customer orders as well, offering a unique setting for testing the effect of inventory on dealer pricing. The findings are that these futures floor traders implicitly engage in interdealer trading as an inventory management tool. Interdealer trades are more likely to be position reducing than other trades, at higher costs than offsetting with customers. In addition, the concept of a dealer hierarchy is developed, where some floor traders, who generally are more successful, profit from their trades with other dealers. Furthermore, these more successful traders are more likely to use interdealer trading in position reducing trades, which is consistent with the existence of a dealer hierarchy. © 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:923–944, 2004