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Dark Pools for Futures?


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Dark Pools for Futures?

  #1 (permalink)
DavidCarmichael
Bangor, Wales
 
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I've just finished reading the Scott Patterson book 'Dark Pools' (a good read, but not quite as good as 'The Quants'!), which mostly focuses on the way in which these relate to equity trading, although there is a brief mention of HFT methods for front-running futures.

Anyway, a bit of googling ( Futures Wiki, What Are Futures?, Futures Definition) would seem to suggest that these contracts always trade on major exchanges. But is there any reason, in principle, why they have to? If they're completely standardized, what is to stop a group of traders exchanging positions outside of an exchange? Is it because no brokerage firm is willing to accept transfer outside of an existing exchange, and if so why, as surely it would be more economical for them?

In other words, why have dark pools become so prevalent in equities but not in futures?

Can anyone with a better understanding shed any light on this (no pun intended!)?

Dave

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  #3 (permalink)
 
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 SMCJB 
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DavidCarmichael View Post
I've just finished reading the Scott Patterson book 'Dark Pools' (a good read, but not quite as good as 'The Quants'!), which mostly focuses on the way in which these relate to equity trading, although there is a brief mention of HFT methods for front-running futures.

Anyway, a bit of googling ( Futures Wiki, What Are Futures?, Futures Definition) would seem to suggest that these contracts always trade on major exchanges. But is there any reason, in principle, why they have to?

Interesting question. The reason they have to trade or clear at one major exchange is that the exchange is the one who guarantee's the trades.

There are some futures that are identical but trade on different exchanges (NYMEX Light Crude / ICE WTI is on example) but they are not fungible, from a margin or delivery perspective. Meaning that even though they have the same risk you actually have two positions not one.

DavidCarmichael View Post
If they're completely standardized, what is to stop a group of traders exchanging positions outside of an exchange? Is it because no brokerage firm is willing to accept transfer outside of an existing exchange, and if so why, as surely it would be more economical for them?

This does happen. CME (thru Clearport) and ICE, not sure about other exchanges, both allow you to execute trades off-exchange and then clear them on-exchange through the Block clear mechanism. Word of warning though Block clear normally has higher minimum trade sizes than on-exchange trades. In theory you could set up another electronic matching platform and have everything executed submitted to the relevant exchange. I have actually heard proposals of cross-exchange products been executed like this but nothing ever came of it.

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 baywolf 
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One of the primary purposes for dark pools existence is because liquidity can be difficult to locate for large orders in equity markets.

Futures markets do not typically have this issue because of a few mechanisms like implied pricing and are not limited to a fixed number of contracts, where as in equity markets, a secondary offering or split needs to happen to create more shares.

Also some futures markets like the eurodollar have a matching mechanism of pro-rata priority instead of FIFO matching, so there is arguably an incentive to display your large order on the book if you want to get filled at a particular price. The larger your share of displayed volume, the more share you would get if a large market order or implied order from another month contract is executed. So for those reasons I don't see how dark liquidity in futures would make a traders job easier.

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 berbeshter 
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baywolf View Post
One of the primary purposes for dark pools existence is because liquidity can be difficult to locate for large orders in equity markets.

Futures markets do not typically have this issue because of a few mechanisms like implied pricing and are not limited to a fixed number of contracts, where as in equity markets, a secondary offering or split needs to happen to create more shares.

Also some futures markets like the eurodollar have a matching mechanism of pro-rata priority instead of FIFO matching, so there is arguably an incentive to display your large order on the book if you want to get filled at a particular price. The larger your share of displayed volume, the more share you would get if a large market order or implied order from another month contract is executed. So for those reasons I don't see how dark liquidity in futures would make a traders job easier.

Just came across this old discussion.

I think a dark pool would still be advantageous to institutions wanting to hide what they're doing and lock in price.

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 SMCJB 
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There are 'Over-the-Counter' ("OTC") Brokers that do exactly that. Trade is consummated off exchange and then cleared on exchange. Another reason a darkpool wouldn't work so well in futures, is that the universe of traders isn't big enough. There really aren't that many people out there with order sizes that large. It's not like equities where there are literally thousands and thousands of people moving very large blocks of shares around.

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