It’s not often when competing exchanges unite – unless there is a very compelling reason.
Well, now it seems the U.S. 12 options markets have joined forces to combat trading glitches in their market. Taking a cue from the their equity market counterparts, the bourses have gotten together and written new rules aimed at stopping erroneous trades, according to a report from Reuters, which said it had viewed a draft of the proposed rules.
Under the proposed rules, unintended trades placed by professional traders will usually have their prices adjusted to levels as close to their fair market value as possible, while wrong trades by retail customers will be mainly be undone, five sources with knowledge of the matter told Reuters.
The rationale behind the rules is simple – stop a bad trade in its tracks before it can escalate into a market wide meltdown. Whether the mistake is caused by a “fat-finger” or a rogue algorithmic strategy that is left unchecked, the rules are designed to meet the large chorus of market participants, pundits and regulators’ who want to protect investors from a market that has gone mainly electronic.
The U.S. equity markets already have rules and procedures aimed at stopping or slowing trading in the event of an erroneous trade or rogue algorithm, such as revised single stock circuit breaker rules, kill switches, Reg SCI, volatility curbs and limit up/limit down guidelines.
Trading glitches have become more prevalent in the trading markets thanks to the rise of electronic trading. Goldman Sachs and Knight Capital Group, the forerunner of KCG Holdings, have both suffered losses at the hands of electronic trading errors that cost each firms millions of dollars.
The increased rule making comes thanks to Securities and Exchange Commission Chairwoman Mary Jo White, who last year ordered the heads of the exchanges to take specific steps to make the cash equities and options markets more sound, including a unified rule for obvious errors for options trades.
Reuters reported that the exchanges have been fine-tuning the plan with the help of the SEC since June, and expect to file it with the regulator in four to six weeks, according to one of the people. All of the sources asked to remain anonymous because the details are not yet public.
As with all proposed regulations, once filed it will be subject to a public comment period and subsequently reviewed by the SEC itself.
Options exchange operators NYSE, which is owned by Intercontinental Exchange Inc (ICE.N), Nasdaq OMX Group (NDAQ.O), BATS Global Markets, CBOE Holdings (CBOE.O), International Securities Exchange, owned by Deutsche Boerse (DB1Gn.DE), and BOX Options Exchange, owned by TMX Group (X.TO), declined to comment for this story, as did the SEC. Miami International Holdings Inc did not respond to Reuters’ request for comment.
Options trade across a dozen different exchanges, and each exchange has its own rules for how to deal with mistaken trades.
Allowing different treatment for professional traders versus retail investors seemed like a middle ground, Reuters reported its sources said. Retail trading accounted for 24.3 percent of options market volume in the first half, according to TABB Group.
Under the rules, a trade is deemed obviously erroneous if its price differs dramatically from the market level for that option soon before and after the transaction was executed.
But the rules also allow market participants to change trades that were harmed by unexpected market movements that had nothing to do with technical glitches: a trade can be deemed obviously mistaken even if the price movement that triggered the trade was just a market gyration after a surprising event.
