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John Turney
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Foreign Exchange Infrastructure: Yesterday, Today and Tomorrow

In this exclusive to Traders Magazine, John Turney, Global Head of Outsourced FX at Northern Trust, discusses the evolution of the fx infrastructure and what is to come.

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August 14, 2007

Options Industry Extends Penny Pilot

By Peter Chapman

The Securities and Exchange Commission, satisfied with the results of the six-month-long penny pilot program, told the nation's options exchanges to extend and expand it.

SEC staff are recommending the exchanges undertake a two-stage expansion of the penny quoting and trading program. The pilot began in late January. The current program, encompassing 13 options, will be extended until September 27, 2007. It was initially due to expire last month.

The first phase of the expansion is scheduled to begin on September 28, and last for six months. Another 22 options will be added, bringing the program total to 35.

Those 35 options represent 35 percent of the options industry's average daily volume. New names include options on Altria, Apple, Citi, AT&T, Yahoo, GM and the Spiders, an exchange-traded fund based on the S&P 500. A complete list is posted on the Chicago Board Options Exchange's web site.

Excluded from the list are options on Google, as it is too volatile and has too many strike prices; the Nasdaq 100 and Russell 2000 indexes; and single listed names such as the OEX and SPX.

Phase 1 is scheduled to end on March 27, 2008. Then a year-long Phase 2 would kick in, adding another 25 to 30 actively traded names to the list. Phase 2 would end on March 28, 2009. The SEC is shooting for a total of about 63 names, sources say.

The terms of the new program are the same as the original. Options traded for less than $3 will be quoted in pennies. Those over $3 will be traded in nickels.

The SEC's new plan comes shortly after the exchanges submitted their analyses of the first three months of the pilot. It also follows a statement from the SEC that the regulator was pleased with the pilot's results, especially the decrease in spreads.

In general, penny quoting has resulted in a large decline in spreads and size at the top of the book in the 13 names affected. It has also caused volume to drop considerably in all names except the two ETF options. Capacity concerns have proved largely unfounded, as the exchanges' quote-mitigation strategies have worked well.

The new program reflects the concerns of some of the exchanges that the SEC not proceed too quickly and aggressively in expanding the number of options traded in penny increments.

"I think this is a well-thought-out and measured approach," Mike Bickford, senior vice president of options at the American Stock Exchange, told Traders Magazine. "We were concerned about there being adequate time to assess the pilot. We should come out of this with a real good understanding of how quoting and trading in pennies will affect the industry."

Other exchanges including the International Securities Exchange had asked the SEC for more time to beef up their quote-handling capacity. The ISE told the SEC in May that "to process quotes in pennies up to $3 will require that quoting capacity be doubled." The cost of such a capacity increase would also be high, the ISE stated.

In general, the ISE and the CBOE, the two largest exchanges, advised the SEC to take a go-slow approach to any expansion of the pilot. NYSE Arca and the Boston Options Exchange were more eager for expansion.