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December 5, 2008

CBOE Has Better Idea and Pushes New Penny Plan

By Peter Chapman

The Chicago Board Options Exchange, upset by the impact of the penny pilot on options trading, has proposed a more muted version of the pilot to the Securities and Exchange Commission once the pilot ends.

Currently, 63 options classes are trading in either penny or nickel increments, depending on their prices, as part of a pilot program that ends next March.

Going forward, the CBOE wants the SEC to extend penny and nickel trading to all options classes, but reduce the number of those classes trading in pennies.

In its proposal to the SEC, which is endorsed by the Securities Industry & Financial Markets Association's options committee, the CBOE suggests trading in penny increments be limited to those options with prices less than or equal to a dollar. All others will trade in nickel increments.

According to Ed Provost, CBOE executive vice president, the proposal would result in 35 percent of all options trading in pennies. Provost was speaking at this year's Security Traders Association national conference.

The plan is a softer version of the SEC-driven penny pilot. Under the pilot, options trade in pennies if their strike price is $3 or less. Currently, half of the volume in the 63 pilot classes trade in pennies.

While the program has benefited retail investors with narrower spreads, it has hurt institutional investors who find less liquidity at the inside quote. Spreads have dropped about 50 percent, according to Provost, while size has plummeted by 70 percent to 80 percent.

The plan, Provost told the STA gathering, represents a "fair and proper balance between interests of retail customers who are happy to see that narrower spread for 20 up because their average order size is 16 to 17 contracts, and institutional customers who need far greater size."

At least one brokerage executive finds merit with the CBOE proposal. Randy Frederick, director of trading and derivatives at Charles Schwab, told Traders Magazine that "Spreads have tightened [in penny-quotes options classes], but the drop in the amount of liquidity has been greater," he said. "It makes sense for low-priced options to be in pennies. For those that aren't low-priced, it doesn't make good sense."

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