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FLASHBACK FRIDAY: New York Stock Exchange Roils Options World

Traders Magazine Online News, June 16, 2017

Mark Longo

It was a time of acquisition mania in the options mart back in 2005 as the NYSE has just purchased rival Arca Ex, which in turn had itself just acquired the Pacific Coast Exchange. The grab for market share in these equity derivatives was the key to profitability, the thinking went.

But what about competition and the NYSE having an unfair advantage? Compared to today’s trend of increased fragmentation in options, the idea of monopoly or oligopoly seems ludicrous.

In a recent blog from FlexTrade, the firm wrote that some experts are debating whether the complexity of the listed U.S. options market structure is hurting liquidity providers and driving some market makers out of the business.

Sluggish trading volumes have become a concern recently. Year-to-date, average daily options volume in exchange-listed equity options is down 2.3 % from 2016 with 16. 4 million contracts, according to Options Clearing Corp. In April, total equity options contract volume fell by 10.3% to 269.6 million from 300.6 million the prior year.  At the same time, ETF options volume rose 3.53% and index options volume surged 28.4% in April over the prior year.

“The US options market currently has 15 lit exchanges, four flash mechanisms, eight different auctions, seven complex order books or a total of 37 places to source liquidity,” said Jason Lichten, director, equity and listed derivatives trading strategies, Wolverine Execution Services, who recently spoke on a call hosted by the Security Traders Association.

The state of the options market structure has become a controversial topic. “It’s a pretty tangled web that we’ve woven for ourselves here,” said Lichten, who spoke about institutional trading in options and bringing transparency in a complex market.

Ever since Regulation NMS was implemented in 2006, there’s been an explosion in the number of options exchanges launching electronic matching engines, a cause of fragmentation.

Options exchanges have continued to create new venues to cater to the specific needs of options traders, such as speed, price or who gets priority in the trade. Since 2008, nine options exchanges have been rolled out to offer investors more choice.

Last year, MIAX Pearl made its debut raising the number to 15. Experts are expecting one more exchange to launch in 2017, bringing the total up to 16 exchanges, which will further bifurcate the landscape for liquidity.

Each exchange is betting that competing market structures can co-exist under the same roof, appealing to distinct customer segments. However, each exchange has a similar model, whether pro-rata or price/time priority, said WEX’s Lichten. Options exchanges have also adopted make-take, in which a trader is paid a rebate for posting a limit order, or charged a fee for removing liquidity. Another model in reverse is taker-maker in which a trader is paid a rebate for removing liquidity because this attracts high-speed traders who are charged a fee per contract for posting liquidity.

So, where does this leave traders? More options exchanges and more choices?

One thing is certain, there are now currently four major exchange families – CBOE/BATS, Nasdaq/ISE, NYSE (Arca, Amex), and MIAX Options Exchange. And each one runs multiple venues that span different methods of execution, such as price-time priority, or pro rata, customer priority, and fee schedules including maker taker and taker maker. And despite the consolidation that has occurred, there is still the same number of exchanges.



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