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January 3, 2011

BATS Eyes Directed Orders

By Peter Chapman

BATS is courting the wholesalers. The BATS Exchange Options Market is seeking approval from the Securities and Exchange Commission to offer a directed-order program. Such programs, which guarantee market makers order allocations regardless of their standing in the queue, are standard on the four "traditional" exchanges. They have been shunned by the "flat model" exchanges such as BATS, which require all members to compete for allocations based on price and queue position.

With its proposal, BATS, one of the smallest exchanges, is attempting to appeal to the market makers who dominate options trading, but at the same time stick to its price-and-time principles. Under directed-order programs, exchanges steer the orders of retail brokerages to specific market makers. Those dealers are then allowed to trade against as much as 40 percent of the order if they are quoting at the market's best price.

Under BATS's program, a market maker will be able to trade against 100 percent of any incoming order as long as it price-improves the order over the market's best price. To facilitate the price-improvement process, BATS will allow all members to use a new hidden order type that price-improves any incoming order. In addition, if another member is offering the same amount of price improvement as a market maker in the program, he gets any incoming directed order, not the market maker.

Unlike the four traditional exchanges, BATS says it does not intend to start a complementary payment-for-order-flow program that helps market makers win business from the retail brokerages.

SEC approval for BATS may not be quick and easy, according to one observer. "We suspect that the new structure of the BATS program might be opposed by the other exchanges, who could see the potential program as a threat to their own directed-order programs," Richard Repetto, an analyst with Sandler O'Neill & Partners, noted in a recent report.


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