New Options for Options Markets
September 21, 2009
Fee models are not the only pieces of options market in motion. So are the types of customers and the flexibility of setting prices, expiration dates and other components of contracts.
NYSE Arca remains the only options exchange offering the traditional maker-taker fee model, which appears to have hit an execution-volume ceiling. Paul Finnegan, senior director at NYSE Euronext U.S. options, says the pro-rata exchanges' step-up auctions are inhibiting orders from being routed to NYSE Arca's more aggressive bids and offers.
"The ISE and CBOE both have incentives in place for those orders to be flashed or price-improved before being routed out," he says.
Maybe not for long, though. Last Thursday, the Securities and Exchange Commission sought comment on a proposal to ban flash orders, which give a market-center's members a brief instant to act on the orders before they're routed to the best price elsewhere.
The SEC is also expects to decide this fall whether to expand further the exchanges' pilot to quote options in penny increments.
That pilot, now applying to 62 options classes and representing more than half of all options trading volume, has dramatically tightened the bid/offer spread and reduced quote liquidity. It has also drawn proprietary trading firms seeking to arbitrage pricing discrepancies. Tabb Group estimates those firms will make up 6% of trading volume this year compared to 2% last. This could rise to as much as 19% by 2011.
Changing faces have also prompted exchanges to adapt in other ways. The ISE, for example, is adopting a new "professional customer" designation, in which individual customers with more than 390 trades a day no longer have priority on the order book. Even so, ISE isn't charging them the market-making trading fee. "The new designation puts customers that are high-frequency traders on a level playing field with broker-dealers and market makers since their trading activity more closely resembles those market participants," says an ISE spokesman.
The CBOE, meanwhile, has recently amended its FLEX Options program to give institutional investors greater ability to customize exercise prices, expiration dates and other components of large orders, seeking to draw over-the-counter options to the exchange. It's now working with the SEC to make the program available to investors executing smaller orders. "We're working closely with the SEC to lower the size requirements," says Edward Tilly, vice chairman of the CBOE, adding customer-protection measure a major focus.
