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December 16, 2010

2010 Review: Options Exchanges Cotton to Maker-Taker

By Peter Chapman

Maker-taker has gone mainstream. The pricing structure--ubiquitous in equities but a niche in options--took a big leap forward this year in the marketplace for puts and calls. Nasdaq OMX PHLX and the International Securities Exchange both began paying liquidity suppliers and charging takers for trades in some of their most actively traded options.

The result was a big break for options market makers, who supply most of the liquidity and are suffering from the effects of penny trading. It was a setback for retail brokers who do most of the liquidity taking. Historically, market makers have paid whether they were taking or supplying, and brokers have traded for free.

The Philly's move was the most dramatic, paying market makers 23 cents per contract to supply liquidity in select names and charging customers 25 cents or 40 cents, depending on their classification. The ISE's plan was more conservative, paying market makers just 10 cents and only charging those customers who traded more than 100 contracts at a shot.

Neither exchange scrapped its traditional order allocation model to adopt the time-priority model of the mainline maker-taker exchanges. Market makers on Philly and ISE still get parity with other quoters and a pro-rated slice of any incoming order.

The impact on the market was immediate and dramatic. In May, the first full month following the pricing changes, maker-taker pricing was in effect for two-thirds of all volume in the popular SPY contract.

The move did wonders for Philly's market share. The exchange is now the largest when it comes to trading single-stock options. Its market share stood at 24 percent in October, up from about 17 percent a year ago. ISE, however, did not get a lift from the change. Its share of the equities options market continues to drift downward. It hit 19 percent in October, down from 28 percent in the year-ago period.

The Chicago Board Options Exchange also threw its hat into the maker-taker ring. On Oct. 29, the CBOE launched a second options market called C2. Like Philly and ISE, it marries maker-taker pricing with parity and pro rata allocations for market makers. C2 rebates market makers 15 cents per contract for supplying liquidity. It charges customers 15 cents or 40 cents to take liquidity, depending on their classification.

With the pricing changes, seven of the nine options exchanges now employ maker-taker schemes. The two holdouts are CBOE and NYSE Amex Options, part of NYSE Euronext.

CBOE's response was to launch C2. Amex has indicated it may also adopt maker-taker pricing. Amex, however, has charted its own path to market share gains by trying to sell a stake in itself to a group of market makers. (That deal, announced in September 2009, has yet to close.)

And what of the future? Philly has about 80 names in its maker-taker program. ISE has 100. Is there room for expansion in the number of options traded? There may not be. Indications are that maker-taker is only successful in the most liquid names. Philly experimented by dropping a Top 120 option into the program and incurred a loss of 5 percent in its market share for that product, said Tom Wittman, Philly's president.

"The added rebate didn't make that much difference," Wittman said at this year's Futures Industry Association/Options Industry Council conference. "It makes a difference in the Top 100 or whatever. We're trying to find a balance. We think it's somewhere in the Top 100."

 

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