Nasdaq Options Market, which launched in March, is betting it will outperform its competitors under some of the new execution-quality report guidelines expected to be recommended by the Securities Industry and Financial Markets Association.
SIFMA recently sent each options exchange a third draft of a laundry list of execution quality statistics it believes the exchanges should publish every month. The data mirror some of the data required under the Securities and Exchange Commission’s Rule 605 reports for the cash equities business and are intended to help brokers determine where to ship their orders. The exchanges are expected to implement the program later this year.
Nasdaq is hoping one of the stats will help to make it more attractive than its rivals. That stat concerns price improvement. Among the various execution quality data included in SIFMA’s latest set of proposed recommendations, issued in a letter to exchanges in late April, is the percentage of order flow that gets price-improved. The price improvement data accompany other stats such as the percentage of orders and volume received and filled on each exchange, the percentage executed at the national best bid or offer, and the percentage that’s traded through the NBBO.
Adam Nunes, head of Nasdaq’s new options exchange, said trades via Nasdaq’s “price-improving” order type fall into the report’s main price improvement category, while trades resulting from the price improvement “mini-auctions” at several exchange do not. “My read is that the price improvement process we have, which is accessible to everyone, would be included in the execution quality report’s price improvement calculations,” he observed. “But SIFMA’s letter makes it clear that anything that offers price improvement to selective participants wouldn’t be included.”
Nasdaq’s price improvement is also immediate, while the price improvement provided through the mini-auctions isn’t, Nunes said. Nasdaq’s price-improving orders allow participants to submit penny-priced limit orders in non-penny names that can execute against incoming marketable flow. However, the orders are displayed at the allowable increment rather than their true price.
There is some uncertainty in the industry about how executions resulting from Nasdaq’s price-improving orders should be reflected in the execution quality reports. However, it’s clear that price improvement from the mini-auctions would be included in an additional category on the execution quality report that highlights the price improvement provided to selective market participants. According to the SIFMA letter, since the auctions on the various exchanges differ from one another, this category would also include information that fleshes out how an exchange’s particular auction works.
SIFMA’s letter outlining the proposed stats to be included in the reports notes that “Unfavorable, Improved, and Effective Spread data is to be calculated based on transparent and accessible market data that all market participants can see and respond to [and] must be distinguished from data which only selective market participants can view, such as PIP, PIM, and AIM.” The acronyms refer to the mini-auctions at, respectively, the Boston Options Exchange, International Securities Exchange and Chicago Board Options Exchange.
A CBOE spokesperson said the CBOE endorses SIFMA’s recommendation. She noted that SIFMA’s “reasoning is that firms and liquidity providers decide which orders are to be availed of on these [price-improvement mini-auction] systems. SIFMA wants the price improvement figures in a Best-Ex report to include only those orders entered in the regular way which receive price improvement.” She did not comment on Nasdaq’s price-improving order type.
The SEC considers the planned execution quality reports vital to the options industry. Erik Sirri, director of the SEC’s Division of Trading and Markets, has stressed the importance of immediate price improvement as part of those stats. “In today’s options markets, one of the most pressing issues is the opportunity for price improvement, and particularly any potential trade-off between improved prices for the customer and payment to the broker for order flow,” Sirri said in a speech at an Options Industry Council conference in Las Vegas earlier this month. “To fully illuminate this issue, I believe the reports must include statistical evidence that enables the public to balance the probability of obtaining price improvement with the risk, if any, of ultimately obtaining an execution worse than the quotes at the time of order submission.”
Regarding the price improvement data from mini-auctions that would be recorded in an additional category on the report, Nasdaq’s Nunes said: “Inasmuch as the prices are not available to all, it was an accommodation to put this in the report.” Nothing, he added, prevents exchanges from creating their own stats and publishing them on their web sites.
As an industry, Nunes noted, “we want to make sure we’re putting out fair and objective stats that provide information to order-sending firms [so they can] determine where they send orders. If we do that, and do it fairly, exchanges will compete to make sure they have good execution stats.”
Travis Larson, a SIFMA spokesman, declined to comment on the price improvement statistics but said that, in general, the group’s final report recommendations aren’t expected to differ significantly from the latest version. Implementation of the execution quality reports is expected to occur in the third quarter of this year, delayed slightly from the earlier goal of the second quarter.
