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June 18, 2008

GETCO Aims Toward Options

By Nina Mehta

GETCO, one of the largest providers of liquidity in equities, plans to step up its participation in U.S. options. Brian Nigito, an executive at GETCO, said his firm is currently "underrepresented in options."

Speaking at an industry conference in Las Vegas in early May, Nigito said GETCO could make a go of trading options on an exchange employing either price-time priority with maker-taker pricing or the traditional pro-rata dealer model with customer priority. In

the former exchange model, orders at the best price are executed on a first-come, first-served basis. In a quote-driven model with customer priority, customers jump to the head of the line and trade for free, while dealers quoting at the best price are typically guaranteed up to a certain percentage of incoming orders.

These two different market structures vie for traders' order flow. In the current penny-quoting environment, maker-taker pricing, imported from the equities trading arena, has gained a foothold.

GETCO doesn't know which market structure will eventually dominate options trading, Nigito said. However, he added, the trading firm sees more benefits in the price-time model for options quoted in pennies. GETCO submitted a letter in support of Nasdaq Options Market, a new price-time priority market, last year.

"In a penny environment, I'm not convinced pro rata is the right model," Nigito said. Price-time priority, in his view, is more appropriate in a market with narrower quotes but less available size. In a penny market, especially "once people can sweep and not wait for the other markets to get out of the way," he said, maker-taker pricing would incentivize liquidity providers to submit interest away from the inside market.

The comment about sweeping refers to "intermarket sweep orders" that several exchanges would like to see introduced in options. They currently operate in equities. ISOs are used to grab liquidity at several price points while executing against the best protected prices in the market, enabling traders to avoid running afoul of the quote-protection rule.

GETCO, a Chicago-based automated trading firm, was founded by traders Stephen Schuler and Daniel Tierney. It's reputed to execute hundreds of millions of shares every day in some stocks. The firm has offices in New York and London.

New players are now entering the options industry, Nigito said. This was spurred by recent changes to portfolio margining that enable individuals who don't fit into either the traditional "customer" or market-maker categories of options participants to compete aggressively for trades by using capital more efficiently. These new players could include the "smaller independent market makers [who have] gone upstairs," Nigito said. This type of market participant, he added, "became the backbone in equities."

Nigito was previously a director in high-frequency trading at Citadel Investment Group. Before that, from 2002 to 2004, he was chief technology officer at INET ATS.

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