NYSE Arca Looks to Expand Options Penny Pilot by 300 Names

NYSE Arca, in a break from the pack, proposed to expand the number of options classes traded in penny increments on its exchange.

The division of NYSE Euronext sent a proposal to the Securities and Exchange Commission this week asking to expand the number of penny-traded options classes by an additional 300 names. The pilot currently includes 63 classes. NYSE Arca intends to phase in trading of the new names in lots of 75 over four quarters beginning in July.

The exchange also proposed expanding the number of series eligible for trading in pennies for two options on ETFs that are already part of the penny pilot. Options traded on the S&P 500 Depository Receipts (SPY) and iShares Russell 2000 (IWM) ETFs are already traded in pennies if their prices are below $3. If they are $3 and above, they are traded in nickels. The NYSE Arca proposal would extend penny trading to those SPY and IWM classes priced at $3 and above.

NYSE Arca made its move as part of a routine request to the SEC to extend the penny pilot. The pilot expires in July and must be extended by request from the exchanges. NYSE Arca has proposed to extend the pilot through December 31, 2010.

NYSE Arca is the first exchange to make its plans public. Its proposal is also more aggressive than proposals previously made to the SEC by some of the older exchanges and is likely to lead to a showdown on the direction of the penny pilot. At issue is the level of “breakpoints.”

NYSE Arca, in its proposal, would like to maintain the $3 cutoff, or breakpoint, for penny and nickel trading. Other exchanges such as the Chicago Board Options Exchange are not happy with the reduction in size at the inside quote brought on by the penny pilot. They have argued for an initial breakpoint of $1. That would limit trading in pennies to those classes trading for less than $1.

“Some exchanges and market participants have been very interested in expanding the pilot into more classes and series, but there are other groups that do not want to expand,” Elizabeth King, an associate director in the SEC’s division of trading and markets, with responsibility for options market issues, said on Wednesday. “Size at the inside has been reduced and there isn’t an agreement as to whether that is a problem or not. Some groups have said that is a big problem and the increment should remain at a larger size in order to maintain the size of the inside. Others have said it’s not a problem and, as in the stock market, trading strategies will change as people adapt to smaller size at inside.”

King was speaking at the Securities Industry & Financial Markets Association’s annual Market Structure conference.

The SEC had planned to make a decision on the future expansion of the pilot in March, but postponed its decision to July due to disagreement among the exchanges.

Market makers are concerned as well about the magnitude of any expansion. “We need to be careful about how far it gets extended into the illiquid names,” Kevin Murphy, a managing director at Citi Institutional Group, told attendees at the SIFMA conference. “We could see a lot more problems.” Murphy added that when the penny pilot first went into effect many Citi clients were clamoring to trade over-the-counter where there was more liquidity.

The SEC will put the NYSE Arca proposal out for comment, King said.