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January 30, 2008

Specialists' Role Declines At NYSE Arca for Options

By Peter Chapman

NYSE Arca, in the latest of a series of moves that diminish the stature of its options specialists, or lead market makers, proposes to reduce their quoting requirements. Under the proposal, which needs Securities and Exchange Commission approval, the exchange would require lead market makers to quote two-sided markets only 90 percent of the time. That is down from a current 99 percent.

At NYSE Arca, 11 lead market makers and 26 "regular" market makers support 2,100 options series. The 55 regular market makers are required to quote continuous two-sided markets 60 percent of the time.

Because there are so many market makers supplying liquidity, NYSE Arca argues it is not necessary for lead market makers to play as significant a role. The proposal by NYSE Arca, operator of a stock exchange as well as an options mart, echoes other recent changes it has made.

A year ago, with the start of penny trading in certain options, the exchange eliminated the lead market-maker assignment in the Quad-Q option. "The issue," Jon Werts, head of NYSE Arca's options operation told Traders Magazine at the time, was: "Would liquidity be adversely affected without the lead market maker? The answer is no." NYSE Arca's plan to make lead market maker support optional won SEC approval last summer. At the time, the exchange said: "Certain highly liquid, highly active options classes have sufficient participation...and do not need an LMM to foster liquidity."

In November, the exchange eliminated the lead market-maker role in the trading of the very liquid option on the iShares Russell 2000 ETF (IWM). It became the second ETF option to trade on Arca without a lead market maker. Both the QQQQ and IWM options are traded in penny increments in accord with the ongoing penny pilot. The penny pilot itself has given NYSE Arca an opportunity to treat lead market makers much the way it does LMMs on its equities market, where they have less clout. For those LMMs assigned to options classes trading in the pilot, Arca now pays them a rebate for providing liquidity, rather than guarantee them a percentage of incoming orders.

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