ISE Calls for Move to Pennies
June 2008
The International Securities Exchange, in a turnaround, is now calling on the options industry to forget the penny pilot and move directly to penny quoting across the board. But the recommendation comes grudgingly, since the ISE did not previously favor penny quoting for all options.
Gary Katz, the ISE's chief executive, says the new stance was driven by the Securities and Exchange Commission's approval of the Nasdaq Options Market, whose rules include the ability to maintain hidden quotes in penny increments in non-penny names. That means Nasdaq could have better prices than other exchanges in some options, although those prices would not be displayed publicly to investors and other exchanges.
"If options are quoted in pennies in one market, they should be quoted in pennies in all markets," Katz told Traders Magazine. "I don't believe in opaque markets. It would be better for the industry if we ended the pilot and traded everything in pennies than it would be to allow dark pennies." Katz described the introduction of so-called dark pennies as "poor market structure." He made similar comments on a panel at the Options Industry Council conference in Las Vegas in early May.
For Katz, this new order type, which Nasdaq calls a "price-improving order," is a departure from the industry's history of mandated transparency. Several exchanges now have reserve orders, but only Nasdaq has an order type that allows for quoting within the minimum allowable increment for options.
Dark, or hidden, pennies aren't limited to Nasdaq. The Chicago Board Options Exchange's request for a dark penny order type was approved by the SEC early last month. NYSE Arca Options and the Boston Options Exchange are considering whether to replicate Nasdaq's hidden order type.
Market makers on the ISE now also want to quote in hidden pennies for options whose minimum increment is either a nickel or dime, Katz said. To stay competitive, the ISE will file to accommodate them. Going down the dark penny route, Katz added, exacerbates the market data capacity issues faced by the industry without improving the publicly quoted market.
According to the ISE, this trend toward hidden quotes is unfortunate for market participants. Customers placing orders in penny increments in non-penny names will see their orders, in effect, traded through by other markets, Katz said. "The impact of having this order type available at Nasdaq, which has just launched, will be very different than having it available at the CBOE, which has 30 percent market share," he said.
R. Scott Morris, BOX's chief executive, observed that many in the industry were surprised Nasdaq's exchange was approved with its hidden orders. "Everyone's going through the four states of realization, from disbelief to anger," he said. He described Nasdaq's price-improving order type as a "fundamental shift in thinking for the SEC in terms of displaying orders."
Morris, who has supported penny quoting in general from the outset, agreed with the ISE's position that pennies would be a better outcome for the industry "than the hidden Nasdaq model." About the SEC, he said, "One could speculate that they were hoping this would spur a comment like Gary [Katz]'s and a call from our marketplace to move to pennies. The SEC has been leading the charge, but there's been resistance from a large part of the community to move to pennies."
Ed Boyle, senior vice president at NYSE Euronext, who heads the company's NYSE Arca Options exchange, said at the options conference last month that the approval of Nasdaq's market, with its hidden quotes, "is a vote for internalization by the SEC." In his view, this isn't a good direction for the industry. He added that the industry should move to full penny quoting across the board.
Nasdaq OMX's Adam Nunes, who heads the firm's options exchange, said his market's price-improving order type is similar to other exchanges' price-improvement auctions. But Nasdaq's order type, he said, offers immediacy in lieu of a three-second delay for price improvement, and is available to all participants.
At the same time, Nunes noted, Nasdaq would like to see the industry move to penny quoting for all names. "If something trades in pennies, we should publicly quote it there," he said. Speed, in a penny environment, becomes more essential. "We think [our exchange] is the fastest in the industry, with an execution time under 1 millisecond," Nunes said.
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