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February 1, 2005

Discounting or Deception? Like Death and Taxes, Payment for Order Flow Goes On and On

By Mark Longo

To be sure, it may seem ironic to listen to the heads of U.S. options exchanges condemn a practice which some of their members sanction. But Frucher says some of the blame is misdirected. "The finger gets pointed at the options industry as though it were the only one that does payment for order flow and that it has been eliminated by pennies in the equity industry," says Frucher. "That's just not true."

Frucher noted that "payment for order flow" is prevalent in the equities markets through complex, but perfectly legal, liquidity rebates. "Virtually every order that is sent to Arca or the Nasdaq is an order that is paid for in one form or another," he says.

So what's the best advice on all of this? Learn to live with payment for order flow because it's not going away. Buyside equity traders need to watch the relationships between their brokerage firms and options exchanges as well as trading houses. If the brokerage firm accepts cash incentive payments in return for trades, then be sure to check your fills and make sure you are getting the best prices.

Mark Longo is an options trader and a former member of the Chicago Board Options Exchange.