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May 10, 2006

The Need for Transparency: Drawing the Line on Counting Options Volume

By Mark Longo

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  • The Need for Transparency: Drawing the Line on Counting Options Volume
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Few subjects in the options world are drier than transparency. However, recent events have suddenly thrust this obscure topic into the spotlight. This renewed interest can be traced back to the explosion of dividend trades in the option markets. Dividend trades are short-term trades involving large numbers of contracts where little capital is at risk and no liquidity is added to the marketplace. The record volume pouring into these trades has re-ignited an old debate about volume in the options industry.

For decades, the industry mantra has been "a contract is a contract." While there were arguments about how to deal with certain types of trading volume such as boxes, crosses and dividend plays, the answer was always the same. If it traded, then it counted, period.

Questions about where a particular contract came from, what it was intended for and what impact it had on the industry were irrelevant. For the exchanges, volume and market share became even more important with the onset of multiple listing in 1999. Intense competition ensued between the exchanges.


Exchanges even paid brokers to route orders to their trading floor. In such a cutthroat environment, transparency was hardly the highest priority.

Multiple listing was a watershed event for the industry. Demutualization in 2005 is a close second. On March 9, 2005, the ISE became the first options exchange to go public. Hoping to follow suit, the remaining membership-based, non-profit exchanges reorganized into for-profit companies. This restructuring activity, along with the exploding market capitalizations of the Chicago Board of Trade and the Chicago Mercantile Exchange, caught the eye of the investment community.

However, analysts and traders don't care about semantic notions like transparency. They only care about fundamental numbers; hence the uproar over the dividend trades. With the PCX and PHLX trading millions of extra contracts every month, the delicate balance within the industry has been overturned. Competing exchanges saw their market shares plummet, something that public and for-profit companies can ill afford, no matter how dubious dividend trade volume may be. "Trying to explain why this isn't real volume' to an analyst who doesn't particularly understand the options business is a very difficult conversation," explains Michael Bickford, senior vice president for options at the AMEX.

The flurry of dividend trades has finally prompted the exchanges to react. They are beginning to segregate the industry's volume. The PHLX and the ISE were the first exchanges with segregated volume reports. The ISE's February 2005 report carried the following disclaimer to explain its decision. "The exclusion of dividend trades from total industry volume data presents a more relevant measure of the relative trends in our business."

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