'Maker-Taker' Fees Losing Out on Options Markets
September 21, 2009
Two of three options exchanges offering the "maker-taker" fee model, which fueled the growth of electronic equity markets by incenting trading firms to provide aggressive quotes, have opted instead to focus on the tried and true formula that instead pleases retail and institutional investors.
The Boston Options Exchange (BOX) and Nasdaq Options Market (NOM) have decided in the last six weeks to move away from the maker-taker model, in which trading firms get paid rebates for "making" liquidity by posting limit orders. Retail or institutional investors, known as "customers," instead pay fees for "taking" liquidity from those markets.
BOX and NOM accounted for 49 percent of the 100 million options contracts that were traded on the maker-taker model in the first quarter of this year, according to the Tabb Group. NYSE Arca accounted for 51 percent, Tabb said in its report title "US Options Market Structure," released Wednesday. However, only 12% of the first quarter's overall 860 million contracts traded under maker-taker pricing.
That means most contracts still trade under the traditional "pro rata" pricing model, where customer orders are executed based on the number of contracts involved. Customers trade free--and are given execution priority over market makers and proprietary trading firms. Market makers also pay a fee that is pooled by the exchanges and redistributed back through those market makers to pay broker-dealers representing customers for their order flow. This is known as payment for order flow.
Broker-dealers catering to those types of clients can claim victory, at least for now. Chris Nagy, managing director of order routing, sales and strategy at Omaha-based TD Ameritrade, notes his firm has been a vocal opponent of the maker-taker fee structure. "We've felt it would become deleterious to the retail investor if allowed to proliferate," Nagy says.
BOX's and NOM's switch away from the traditional maker-taker model, which rewards limit orders and charges for market and marketable limit orders, appears to represent a fundamental shift back to tradition in the trading of options. The maker-taker model, dominant in the trading of equity shares, rewards liquidity providers-most often market makers and proprietary trading firms-with rebates for setting the national best bid or offer (NBBO) by aggressively posting limit orders.
The fee model fueled the growth of the equity market's electronic communication networks (ECNs) as well as Nasdaq's trading of New York Stock Exchange-listed stocks. The options exchanges adopted the traditional maker-taker model anticipating similar results, but instead their overall market share crested under 20%.
Exchanges, however, can quickly implement fee changes, which means the maker-taker model could be reinvigorated. BATS Global Markets, whose equity ECN rapidly gained market share, in part by offering aggressive maker-taker pricing, now accounts for 12% of U.S. equity trades. BATS plans to begin to operate a U.S. equity options exchange in early 2010.
Jeromee Johnson, vice president of market development at BATS, says the exchange still plans to offer maker-taker pricing, relying on its technology and a "clear set of incentives" to attract orders at the best bid or offer. Johnson added that a major contributor to BATS success has been its ownership by a high-powered group of brokers and trading firms. "It aligns us with their interests," Johnson said.
