The American Stock Exchange is making an aggressive push to win business in “dividend spread trades.” The move is controversial, because these large trades are often criticized for having little economic value and boosting exchanges’ volume and market-share figures. To better compete against the three other options exchanges that operate trading floors-dividend spread trades are negotiated trades that occur only on floors-the Amex dropped its fees 90 percent in January. Amex’s goal is to draw volume from NYSE Arca Options, the Philadelphia Stock Exchange and the Chicago Board Options Exchange, all of which enable market makers to cross these trades on their floors. The trades allow market makers to profit from options strategies involving stocks that are about to go “ex-dividend” (see sidebar).
So far, Amex’s plan isn’t working. The new pricing, which lowered Amex’s fees to a daily maximum of $100 for spread trades in each options class (with a total monthly cap of $12,500), led to “little additional business,” says Michael Bickford, senior vice president in charge of options at the Amex.
The exchange’s earlier fees for dividend spread trades maxed out at $1,000 per day, with a $50,000 monthly limit. The other three exchanges currently have maximum daily fees of $750 or $1,000, and monthly caps of either $25,000 or $50,000. NYSE Arca Options has the biggest share of dividend spread trades, followed by Philly; Amex’s share is currently negligible (see tables).
But it doesn’t matter that Amex volume didn’t budge, according to Bickford. He says the exchange wasn’t stumping for dividend spread trades and therefore hasn’t widely marketed the reduced fees.
“It’s unclear why someone needs to do multiple times the [options] open interest in the strategy,” Bickford says. “You have to wonder if part of the intent [behind exchanges encouraging this business] wasn’t to distort volume numbers as well.” However, he says, Amex decreased its fees because the volume of dividend trades has grown significantly-and “if it’s going to happen, if someone is price-sensitive, they may as well do the trades here.”
The International Securities Exchange has been an outspoken critic of dividend spread trades for a year and a half. “It’s a practice we don’t believe in,” says Bruce Goldberg, chief marketing officer at the ISE. “Investors are disadvantaged, and the practice results in a fiction in terms of higher volume and market share.”
Bickford doesn’t disagree with critics. “You’d get a truer sense of actual volumes and market shares without these trades,” he acknowledges. “If we were shareholder-owned, we would have to answer to security analysts on every little hiccup in market share, and I think we would have to be more vocal about the practice.”
Dividend Spread Trades
In these low-risk trades, market makers hold long and short call options that are in-the-money call options on a stock that is about to go ex-dividend. The trades usually take place the day before the ex-dividend date-the last day stockholders can buy the stock to qualify for the dividend. Since the exercise prices of call options are not altered to reflect upcoming dividend payments (unless the dividend is at least 10 percent of the share price), call option holders can profit by exercising those options.
The dividend spread trade is profitable if the market maker is not “assigned” the in-the-money call option. If the holder of the call option forgets or declines to exercise the option, the market maker does not have to deliver stock to that holder and can profit from the long side of the spread trade. -Nina Mehta
