Surfing the volume curve

Algo Review

The first apartment I lived in by myself had a bocce court.

The deck had more square footage than the studio, even if you counted the large and unfinished basement that came with it. So after building some benches with embedded planters, it was time to frame out the play scape, line it with astro turf, and dribble cold water into pastis.

This space was great for grilling on weeknights, hosting parties on the weekend, or generally just enjoying whatever bit of greenspace you could get your hands on in New York City. My college roommate lived down the street, and we’d regularly sit around swapping stories from the mines about classrooms and trading floors.

As the Brooklyn Lager flowed, the discussions tended increasingly philosophical. We even joked it should be a podcast called “Curious Joes”; arm chair pontification, waxing young male arrogance of intellect.

Sam had a leg up on me being a philosophy major, and I was immediately reminded of that dynamic yesterday when I got pegged with a theory of knowledge question about options.

Is the market price truth? Jason, Lex and I discuss here. (They stiffed me on a lunch date to discuss in advance, so I’m coming into the topic blind.)

There’s a lot to unpack about that statement, and we have to ask about relative or objective truths, perhaps even a dose of morality. (Are wide markets unfair or just a reflection of the immediate pricing environment?) A simple answer says of course price is true because that’s a trade, and trades are hard market data.

My perspective is that “truth” in terms of an option being priced what it’s worth, is something that has to be achieved over time. Markets are temporarily voting machines with orderflow knocking individual ticks around, but over time they get pretty damn good at weighing fair value. (Buy a straddle every day, and you basically pay a bunch of costs to break even - the options are incredibly well priced.)

And since we’ve been talking about algorithms, the discussion of truth couldn’t come at a better time. The point of using an execution algorithm is to get your average fill closer to the truth. Because you’re a taker of liquidity (even if that involves placing non marketable bids and offers) you have to be nimble and overcome the negative edge of needing to trade.

The most basic way to do this is a TWAP order. We focused on those in the last edition of Algo Review. There are both practical and regulatory reasons why you might want to simply buy a little bit every couple minutes.

Today we’ll talk about surfing the volume curve with VWAP orders. There aren’t enough asterixes for how complex basic volume stats get.