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October 4, 2007

Options Maker-Taker Markets Gain Steam

By Nina Mehta

BNY ConvergEx's Saliba says it's unlikely a public customer would want to hit a bid or take an offer on a maker-taker market if that person has a choice of execution venues. "They're charged more, so they'll clear the other markets first," he says. "Being a liquidity provider on those exchanges could be the last bastion of liquidity provision."

PEAK6, a market maker on NYSE Arca Options, trades on all the options exchanges and incorporates exchanges' pricing schemes into its trading decisions. When the firm is posting liquidity, Ruhana says, it would be glad to post on Arca because of the explicit pricing benefits, "but when we have to take liquidity, we will look for depth at the best price, and then factor the exchanges' cost profiles into our decision."

Changed Flow

It's possible, though, that maker-taker pricing could alter the mix of flow that executes in those markets. After NYSE Arca Options switched to maker-taker pricing, for example, Citadel Derivatives Group says it noticed a difference in the order flow on Arca. According to Matt Andresen, co-head of CDG, the firm found its experience on Arca in the pilot names disappointing.

"The flow on Arca changed dramatically," Andresen says. "Because of the new fees on customer orders, those orders fled for other exchanges. What was left was more toxic proprietary trading flow." Citadel Derivatives Group makes markets on all six exchanges and routes approximately 1 million contracts per day to exchanges on behalf of retail brokerages.

Andresen, who says the firm continues to quote on Arca but not as aggressively, thinks Arca hasn't yet found the right market model with which to compete with the CBOE, ISE and PHLX. He adds that he expects NYSE Arca Options to move toward a model that "more directly incents customer flow to come to their exchange."

Andy Kolinsky, head of sales and client services at Citadel Execution Services, also notes that some "professional traders dabble when there's a new market structure." In his view, part of Arca's gain this year may have resulted from those players. "Without customer order flow, however, it is not a sustainable model," he predicts.

For now, the options exchanges are in a heated battle over which market structure is likely to work best in a changing trading environment. In the penny names, success hinges in part on being at the top of the market. If maker-taker pricing enables an exchange to tighten the spread, the other exchanges must be able to compete with those who better the price.

"We're all very competitive with the two exchanges that are maker-taker," CBOE's Tilly says. "That's the pressure we're under-it's not turning [improving] the market first, though that's great, but making sure that if it's turned in another market, our liquidity providers can make the NBBO." To facilitate that, the CBOE is now examining its pricing tiers for primary market makers for 2008.

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