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June 1, 2010

Options Marts Embrace Maker-Taker

By Peter Chapman

Maker-taker pricing is making inroads at traditional options exchanges.

Two of the country's four traditional options exchanges are expanding their programs that pay rebates to liquidity providers and charge liquidity takers. Both Nasdaq OMX PHLX and the International Securities Exchange are adding new options to their maker-taker programs.

Nasdaq OMX PHLX, which started the maker-taker trend among traditional exchanges last December, added five new names to its roster. The list includes IBM and Brocade, and brings to 56 the number of options traded on the former Philadelphia Stock Exchange under the maker-taker regime. 

The ISE, which launched maker-taker pricing in April for selected options, expanded its list from three options to 20. In April, the ISE launched maker-taker pricing for the QQQQ index option, as well as contracts on Citi and Bank of America. Under the program, the ISE pays market makers 10 cents per contract when providing liquidity.

Both exchanges are targeting the most liquid stocks with their programs. Neither is changing their traditional order allocation procedures.

Nasdaq is calling its program a success. In March, the exchange operator's two options exchanges combined attained a record-high market share of 27.6 percent, according to Ellen Greene, a vice president in charge of sales at the company. That made Nasdaq the options industry's largest exchange operator.  

Ellen Greene

That gain came primarily because of gains at the PHLX, which took 25.7 percent of total industry share in March. That was the highest since the Philly began operations in 1975, Greene said, and is largely due to the success of the new maker-taker program. Greene was speaking at the annual Options Industry Conference in Phoenix.

The older "traditional" options exchanges such as the PHLX and the ISE have until recently charged both the providers and the takers of liquidity. The exchanges have also employed order allocation procedures that dole out incoming orders to liquidity providers based on the size of their quotes and not on their standing in the queue.

That pro rata allocation model, also used by NYSE Amex Options and the Chicago Board Options Exchange, has come under pressure in recent years as the switch to trading in penny increments has eroded market maker spreads. As more and more options are traded in 1-cent increments, paying dealers a rebate to quote is increasingly considered a necessary incentive.

Newer exchanges such as BATS, NYSE Arca and Nasdaq's NOM have made their marks with maker-taker pricing, capitalizing on penny trading as well as the involvement of high-frequency trading firms. They have also eschewed the traditional pro rata models for price-time priority.

Consequently, these exchanges have taken a significant chunk of market share in the penny names.

The moves by PHLX and ISE to maker-taker pricing represent an acknowledgement by these exchanges that pro rata allocation in the most liquid stocks--those with the thinnest spreads--may not be enough to draw sufficient liquidity anymore.

"Our goal was to improve the quality of our market while retaining the hallmarks of that market," ISE executive Jeanine Hightower said at the OIC conference.

On the rebate front, the ISE is, in fact, going even further. It now pays exchange members a 15-cent rebate per contract per leg for certain complex orders, Hightower said. The OIC will also rebate suppliers of facilitation orders 15 cents per contract in certain cases.

Neither PHLX nor ISE are abandoning their policies of allowing retail customers to trade for free. Nor are they jettisoning their allocation models for price-time priority. Retail customers will still have priority over other traders. Market makers will still be rewarded based on quote size rather than their place in line.

As for the other two traditional exchanges, neither the CBOE nor NYSE Amex Options have plans to introduce maker-taker pricing, according to executives with those companies. NYSE Arca Options, Amex's sister company, already operates a successful maker-taker business. CBOE plans to launch an all-electronic options market later this year, which could deploy maker-taker pricing.


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