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Jos Schmidt
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Reducing the Regulatory Burden on Public Companies, Yes Please But...

In this commentary, NEO's Jos Schmidt discusses regulatory requirements and needs in the Canadian equity markets.

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January 1, 2007

Consolidation Expected Among Options Market Makers

By Nina Mehta

A shake-out is looming in the options world. With penny quoting just around the corner, top trading officials are predicting a reduction in the number of options market makers.

"It will further institutionalize options market making," said Joseph Sellitto, marketing director at Susquehanna Financial Group, speaking at the Futures Industry Association's Expo conference in Chicago in October.

"You're going to see larger, stronger players." Susquehanna is a specialist in more than 600 options classes and makes markets in most others.

Sellito noted that decimalization in the equities world forced smaller firms to consolidate or exit the market-making game. He predicts that pattern to repeat itself in options as spreads decrease, reducing brokers' revenues. The six-month penny pilot will roll out later this month in 13 options classes.

Jay Knopf, a vice president at SLK-Hull Derivatives, agreed. Those market makers that persevere will be "big, powerful firms" that can invest enough money in their technology to make them "fast enough to compete."

Technology has become increasingly critical. "The barrier to entry is not access to the marketplace anymore. It's the fixed cost of technology [that] firms will have," said Bastiann Van Kempen, chief executive of Optiver US. Optiver is a proprietary trading firm that makes markets electronically in multiple asset classes in Europe, Asia and the U.S.

In addition to understanding and managing risk, market makers will need substantial revenues so they can take a financial hit and keep on going, SLK-Hull's Knopf said. He added that market-making firms with a global reach will be better positioned than others.

That's because their activities will be diversified, enabling them to reap the benefits of scalability across their operations.

At the same time, computers are increasing the ability of firms to make more markets and reducing the headcount at those firms.

SLK-Hull, one of the largest options market-making firms, for example, no longer has traders on any options floors. It's now a purely electronic market-making firm.

Knopf said that instead of one person making a handful of markets, 12 people can now do 1,000 options classes. SLK-Hull has more people on its technology staff than it has traders, he said.

Much of the decision-making has also shifted over to the computers. "Computers are programmed to make the decisions-and that's where everything is going now," Knopf continued. The computers enable traders to execute orders in milliseconds.