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November 1, 2010

Too Much Quoting?

By Peter Chapman

Should options exchanges lighten the market maker's load? Thomas Peterffy told Dow Jones Newswires in late September that he was losing money due to regulatory discrepancies that enabled high-frequency traders to pick off his quotes.

Boris Ilyevsky

The operator of Timber Hill, one of the largest options market-making units on the Street, threatened to drop some options and possibly even relinquish his market-making license.

The problem stems partly from the fact that registered market makers such as Timber Hill are required by the exchanges to make markets in all series of a particular option, regardless of how much trading they generate.

Timber Hill makes markets in hundreds of thousands of series and must update its quotes frequently. Its inability to do so quickly enough gives HFTs an opportunity to profit at Timber Hill's expense when market conditions change, Peterffy complained.

Ironically, despite all the quoting, the vast majority of options contracts never trade at all. Citadel, another large dealer, undertook a study that discovered 85 percent of listed options series never trade. In addition, 93 percent trade only three or four times per day.

Although the interview was the talk of the options world this fall, exchange executives aren't acting overly concerned.

"Based on our conversations with Timber Hill, I think they continue to have an incredibly high level of commitment to this business," Boris Ilyevsky, a managing director at the International Securities Exchange, told Traders Magazine.

Ilyevsky doesn't believe it would be fruitful to impose obligations on HFTs, as Peterffy suggests.

Still, would it be a problem if market makers dropped some of the less active series? "They're saying they might want to drop some names," Ilyevsky said. "Certainly that's not a great thing, but I don't think it's a big deal. Based on their focus, that would not have a material effect. No one is talking about dropping Spiders."

[Spiders, or SPDRs, are options on the exchange-traded fund based on the S&P 500 Index. They are among the most heavily traded options.--ed.]

 

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