While fragmentation and a lack of stamp duty has helped proliferation of high-frequency trading in Japan’s cash equities market, specialist market-makers are beginning to size up its derivatives market too.
On Monday, March 24, the Japan Exchange Group (JPX) – formed by the merger of the Tokyo Stock Exchange (TSE) and Osaka Securities Exchange (OSE) in January last year – will reach another key milestone of the merger: completion of the integration of their respective derivatives markets onto OSE’s J-Gate platform. Their respective cash equities were merged onto TSE in July 2013.
Developing the derivatives market is a key plank of reform that JPX has committed itself to in achieving its goal of becoming “the preferred Asian exchange”.
Despite JPX standing as the third biggest standalone exchange by market cap after the NYSE EuroNext and Nasdaq OMX, its derivatives exchange only ranked 14th out of 30 last year as tracked by the Futures Industry Association (with 366.1 million contracts traded), well behind Asian bourses such as the National Stock Exchange of India (4th) and Korea Exchange (5th).
The bulk of trading interest gravitated towards the Nikkei 225 options and futures, and mini-Nikkei 225 futures originally traded on the OSE.
JPX has said that its medium-term plan – for fiscal 2013, 2014 and 2015 – is to beef up its derivatives market trading volume to 400 million contracts by 2015, partly through new product development. However, even that will leave it some way short of the derivatives bourse in 13th place - Zhengzhou Commodity Exchange at 525 million contracts. The leader is CME Group with 3.16 billion.
From March 24, listed futures and options on TSE – such as JGB futures and options on futures; and index and options contracts on the Topix currently trading on Tokyo Derivatives Exchange (Tdex) – will switch over to trade on J-Gate.
While some of the old contracts will be retired, new contracts, such as the CNX Nifty futures, will also start trading on Monday. In total, there will be 239 derivatives products traded on J-Gate come March 24.
Japan stands as the only Asian equities market where HFT accounts for up to 60% of its cash market; in markets such as Hong Kong and South Korea, additional costs posed by stamp duty has inhibited HFT activities. Outside of Japan and Australia, HFT strategies are more prevalent in Asian derivatives markets where such charges don’t apply.
Eclipse Options, a specialist options market-maker, started trading Nikkei 225 index options in the summer of 2013 out of Hong Kong. Nikkei index futures and options are listed on OSE.
Eclipse’s head of quantitative strategies, Greg Griffin, says that now all derivatives originally listed on the TSE are being integrated onto J-Gate, this will make it easier for market-makers that had only traded on OSE to also look at trading former TSE options and futures.
“The combined derivatives trading platform means we can basically just flip the switch and start trading,” says Griffin. “We do not need additional work on changing program coding to a different exchange like it used to be the case in the past.”
Griffin says if there was adequate trading volume on Topix and JGB options, he may start trading these products as the more liquid a contract is, the higher the profit prospects for market-makers.
One possible contract that may provide opportunities for statistical arbitrage, a type of HFT strategy, is Topix options and futures originally listed on the TSE, which are correlated to Nikkei 225 options and futures that Eclipse Options is already trading.
In fact, after TSE upgraded its cash trading Arrowhead system to reduce latency to an average of one millisecond for order response and 2.5 milliseconds for information distribution in 2010, the exchange has seen an uptake in pairs-trading strategies in its cash, futures and options markets.
“It has made a very positive influence on all JPX markets, and liquidity on the JPX derivatives market has been increasing,” a JPX spokesperson wrote in reply to AsianInvestor questions, but provided no further details.
Pairs-trading, or statistical arbitrage, relies heavily on high-speed execution and use of algorithms; statistical arbitrage is a broad hedge fund strategy that seeks to profit from the statistical mispricing of one or more assets that can also be unrelated to HFT.