ISE's Iceberg Orders Show Continuing Shift to Equity Practices
Nasdaq Options Market, ISE receive SEC approval to offer reserve orders
March 17, 2008
Days after the International Securities Exchange (ISE) received permission to begin offering reserve orders--a common feature in the equities market--the Nasdaq Options Market was approved to offer similar functionality.
ISE, the largest equity options exchange in the U.S., applied to the Securities and Exchange Commission to introduce reserve, or iceberg, orders four months ago. Nasdaq's proposed rules for its homegrown options venue, which incorporate components of its equity exchange such as reserve orders, received the go-ahead from the SEC on March 12.
Iceberg orders allow investors seeking to execute large blocks to place, for example, an order to sell 1,000 contacts while displaying only 100.
Since the options exchanges began a pilot program of penny price increments in January 2007, trade size has decreased significantly, reflecting what occurred in equities after decimalization was instituted in 2001. Boris Ilyevsky, head of business development at ISE, said that he expects that trend to continue as the pilot's 34 options classes are on March 28 joined by another 28, representing more than half the market's volume.
Because smaller trades make it harder to match big blocks with like-size orders, displaying the large order can result in aggressive market participants trading in anticipation of the impact, making the block more costly to execute.
Algorithms, which typically break up large trades into smaller pieces to execute across the market, have also become prevalent in equities as a way to provide anonymity. They have begun to emerge in options as well, though an option class' numerous strike prices, compared to a stock's single bid and offer, make it far more difficult to design effective strategies.
"It makes sense that people would take pieces of the equities market and throw them at the options market," said Adam Sussman, head of research at Tabb Group. "But it's unlikely some will stick and others will fall to the floor. It's more likely they'll tweak those solutions to make them work for options."
NYSE Arca, the first options exchange to implement a price-time priority execution model and rebates for providing liquidity, rolled out reserve orders last year, but so far hasn't seen much demand. "Reserve orders are relatively new to options and thus far we haven't seen broad use of the order type," said an NYSE Arca spokesperson.
Some brokerage firms provide similar order types. Greenwich, Conn.-based Interactive Brokers Group (IB) allows customers to trickle large orders to the exchanges. Kevin Fisher, head of options block trading at IB, noted that submitting a large trade can result in problems if the exchange's server crashes, because the broker loses control of the order. If, for example, an order's different legs are executed over different venues and one goes down but does not cancel the order, IB will probably seek to execute the leg elsewhere to satisfy the customer.
"We run the risk of a customer not getting an order filled, and the customer feeling entitled to the execution, or a double execution," Fisher said, adding that his firm would likely give a customer the option of retaining the order on its server or submitting to the exchange.
ISE's Ilyevsky said several exchange members probably provide reserve-type services and that the new functionality wouldn't directly result in cost savings. However, hosting the iceberg order at the exchange could result in speedier executions, since there's no messaging traffic between the exchange and broker. And it may indirectly cut technology-related costs, especially for brokerages that do not have the platform of an IB, the largest options brokerage and market-making firm.
