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April 2, 2012

Big Draw: New ISE Policy Brings in Options Market Makers

New ISE Policy Brings in Market Makers

By Peter Chapman

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The International Securities Exchange, in a bid to reverse an ongoing decline in its market share, is expanding the ranks of its market makers.

In the past seven months, ISE has signed up five new market makers and expects to add "a couple more," according to exchange executives. From 20 market makers in July 2011, ISE now boasts 25.

Boris Ilyevsky, ISE

Behind the jump is a change in the way ISE allocates options to its second-tier market makers, known as Competitive Market Makers. Last September, ISE began allowing this group of market makers to pick the options they wanted to trade. Previously, they had to take a bin of hundreds of names that would include the options they wanted as well as many they didn't.

The restructuring made the CMM program more flexible and reduced costs for some market makers. It also created a market in the rights dealers must buy or lease to gain access to allocations. With rights suddenly available, a gaggle of high-frequency market-making firms have joined the exchange.

"The new system has been very successful," said Boris Ilyevsky, an ISE managing director. "We've attracted five additional market makers. That's very significant. We expect a couple more will be joining in the next few months, and with them on board, we will have all of the significant options market makers in the industry quoting at ISE."

The decision to increase competition at ISE was driven by a need to bring in more order flow. More quoters should produce better quotes, which in turn will draw more flow, ISE figures. The exchange has fallen to third from first place in recent years, and is in danger of being further eclipsed by a revitalized NYSE Amex. ISE's market share fell to about 16 percent in February, from about 19 percent last August.

Ilyevsky says the quality of ISE's quotes have improved since the program was retooled. The percentage of time the exchange has the best prices in the overall market has increased, as have the number of contracts quoted at the market's best prices. The exec would not divulge specific data, however.

High Frequency

Among the newcomers, Getco was the first to take the plunge, joining last August. Then an assortment of lesser-known options trading houses joined, including Tibra Trading, Volant Trading, Hardcastle Trading and Allston Trading. Most of these firms were already registered as market makers at the three other exchanges built around market makers. All are high frequency trading shops.

ISE, like most options exchanges, operates with two classes of market makers. Upper-echelon Primary Market Makers are like the old specialists, reaping the greatest rewards but subject to the greatest obligations. CMMs get the leftovers, but have the status of PMMs when they receive orders directed to them by their customers. All of the PMMs are also CMMs.