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August 1, 2012

Gaining Ground

Newest Exchange Embraces Taker-Maker Pricing

By Peter Chapman

The launch of the Nasdaq OMX BX options exchange, at the end of June, marked not only the debut of the industry's 10th exchange, but an expansion of the use of taker-maker pricing.

In contrast to the conventional maker-taker pricing model whereby exchanges pay liquidity providers and charge liquidity takers, BX Options will pay liquidity takers and charge liquidity suppliers. While the scheme is relatively common in the cash equities business, its usage has been limited in options.

Nasdaq has said it expects BX Options to appeal to broker-dealers who are big takers of liquidity and may not be receiving payment for their order flow from intermediaries; or they may be unsure if they are being adequately compensated by their intermediaries. BX Options will not otherwise facilitate payment for order flow.

Gary Sjostedt

Professional traders who trade directly on the exchanges rather than go through an intermediary are expected to benefit. So too are some retail brokerages that deliver mostly market, or liquidity-taking, orders to intermediaries.

"Competitively speaking, this is a positive," said Gary Sjostedt, director of order routing and sales at TD Ameritrade. "It keeps the exchanges on their toes price-wise."

The BOX Options Exchange actually pioneered the taker-maker pricing strategy in the options market in 2009, but was the only exchange using it until this year. Then, in early June, the International Securities Exchange switched 25 options classes to taker-maker pricing.

BX Options instituted taker-maker pricing on July 2, becoming the third exchange to do so. There are differences among the three offerings. In contrast to the ISE, BX Options will offer taker-maker pricing in all options traded in penny increments. In contrast to BOX, Nasdaq will limit the rebate strategy to customers only.

For most of the BX names, Nasdaq will pay 32 cents per contract on customer orders that take liquidity. That compares with 22 cents for BOX's "regular" market and 30 cents for trades in its auction. ISE also pays 32 cents per contract.

BOX chief executive Tony McCormick has dubbed the new Nasdaq exchange "NOX," as he considers it a knock-off of BOX. BX Options has priced its take rebate 2 cents more than BOX's auction rebate, and McCormick said he may have to react. "They priced it at 2 cents over our inducement fee, so we might bump them. Everybody plays that game," he said. Roughly half of BOX's volume is done in its price improvement auction.

BOX went taker-maker in 2009 to attract retail brokers or their intermediaries to send it flow. Previously, due to philosophical objections, the exchange did not offer a standard-issue payment-for-order-flow mechanism. That worked to its detriment as all the other exchanges did. Still, rather than institute a similar scheme whereby it administered market-maker payments to order-senders for their flow, it chose to pay for market orders directly.