Options Market Makers Flock to ISE
Traders Magazine Online News, March 27, 2012
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.
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 didnt.
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. Weve attracted five additional market makers. Thats 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. ISEs market share fell to about 16 percent in February, from about 19 percent last August.
Ilyevsky says the quality of ISEs 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 markets best prices. The exec would not divulge specific data, however.
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.
ISE is actually the last of the four dealer-centric exchanges to loosen the rules governing allotments. It follows the Chicago Board Options Exchange, which reworked its program a few years ago. In fact, ISEs changes mirror those of CBOE. Both exchanges allow dealers to cherry-pick. But neither exchange makes it cheap.
In contrast to the programs at NYSE Amex and Nasdaq OMX PHLX, where all options cost roughly the same, the programs at CBOE and ISE make the more liquid classes more expensive. ISE bases its pricing on the value of the class, an exec explained, which is based on how much trading is done.
At both Amex and the Philly, a market maker can trade any 100 names for $5,000 per month by buying a trading permit from the exchange. At ISE, a market maker must lease a right from another member. The cost is between $6,500 and $10,000 per month, sources tell Traders Magazine. The first right obtained lets the dealer trade options representing 20 percent of total industry volume. That might only be two options. Apple and the Spider ETF combined account for nearly 20 percent of total volume.
If a market-making firm wanted to trade all options listed at ISE, it would need to buy or lease nine rights. A lease could cost about $80,000 per year at ISE. By contrast, at the Philly, a firm pays $11,000 per year for four permits to trade all names. The equivalent price at Amex is $20,000.
The ISE and the CBOE are both pricey, said Danon Robinson, founding partner at Toro Trading. Compare them to the Amex or the Philly or (NYSE) Arca, where you pay $4,000 or $5,000 and you get to trade anything you want. They all have very clear, simple permit structures. Why complicate things? Toro is a market maker on Amex, Philly, and CBOE, but not ISE.
And with 25 market makers, making money at ISE is getting tougher for the old-timers. Denis Medvedsek, head of options market making at Knight Capital Group, noted the ISEs move could be a plus for ISE, as it could bring in more flow. But its not such good news for market makers. More competition is not necessarily good for market makers, he said. Medvedsek added, however, that the ISEs move could work to market makers advantage, as it allows them to sell or lease their surplus rights.
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