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Citadel Fuels Options Fight
Traders Magazine, October 2008
The options industry is edging toward a fight over access fees and payment for order flow. This was kicked off by a letter Citadel Investment Group sent the Securities and Exchange Commission on July 15, petitioning the regulator to impose a cap of 20 cents per contract on access fees for non-members executing against displayed quotations on exchanges. That letter caused NYSE Arca Options and automated market maker GETCO to go on the offensive.
Citadel's missive took aim at take fees on maker-taker exchanges. These exchanges charge liquidity takers for removing liquidity from their books and pay providers of liquidity. "Requiring broker-dealers to send their orders to the markets displaying the best quotations while also requiring them to ignore the fees associated with obtaining access to those quotations would allow markets to charge excessive fees, and could result in executions at prices materially different from the displayed quotations," Citadel told the SEC. Brokers executing orders in the options industry, as in equities, are prohibited from trading through better displayed prices in the market.
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Citadel added that it was imperative the SEC "address distortions in the options market caused by the excessive take fees that may be charged by options exchanges using maker-taker pricing." The firm said a cap would "ensure the effectiveness of quotations in the options markets and address many of the same concerns that the Commission addressed in the equity markets when the Commission adopted Rule 610(c) of Regulation NMS to cap access fees in those markets."
Last month, NYSE Arca Options and GETCO separately argued that the SEC should reject Citadel's plea, charging that Citadel was skewing the debate by ignoring the presence of payment for order flow in the options industry. GETCO called payment for order flow programs a source of "enormous conflicts of interest" and said those payments to retail broker-dealers are the "true cause of price distortions in the options markets rather than the transparent taker fees charged on maker-taker options exchanges."
The four traditional exchanges typically don't charge public customers for executions. Instead, they impose transaction fees on broker-dealers and market makers. They also facilitate payment for order flow. Through exchange-sponsored programs, market makers executing against customer orders on those exchanges are charged a marketing fee, which goes into a pool controlled by the market maker assigned to that option. That market maker periodically allocates payments to broker-dealers that provided the order flow.
Arca said the SEC should squash Citadel's petition because it is "too narrow in scope" and doesn't foster fair and orderly markets or transparency. Instead, Arca said, the SEC should conduct a "comprehensive study not only of the fee structures of options exchanges but also of the financial inducements offered by such exchanges to attract order flow."
At the heart of the current debate are the take fees charged by three exchanges for executions in option issues that are in the penny pilot. These maker-taker exchanges are NYSE Arca Options, which has 12 percent of the industry's volume, Boston Options Exchange, and Nasdaq Options Market. In early September, all three charged 45 cents per contract to take liquidity in options that are in the penny pilot. (The minimum spread for penny names if $1, since the minimum price variation is based on the option's premium, which is calculated on a per-share basis, while a contract is typically for 100 shares.) Maker-taker exchanges earn the spread between the take fee they get and the liquidity provider rebate they offer market participants.
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