SEC Approves Expansion of Options Penny Pilot

The Securities and Exchange Commission today approved NYSE Arca’s proposal to expand the so-called "penny pilot" whereby options trade in penny increments.

The decision means that, within a year, industrywide, 300 more options will trade in pennies. That means 363 options, representing over 85 percent of volume, will be traded in penny increments. Currently 63 options, representing 50 percent of volume, are traded in pennies.

The SEC’s approval only applies to trading at NYSE Arca, but it is expected that the six other exchanges will follow suit. If they don’t they could end up violating new trade-through rules adopted by the options industry.

Specifically, under the expansion, options trading for less than $3 will trade in pennies. Those trading for $3 or more will trade in nickels. NYSE Arca’s plan calls for a phased rollout beginning October 9. During each of the next four quarters, 75 new options will start trading in pennies. The rollout will end on July 10 of next year.

NYSE Arca’s plan was opposed by many traders and exchanges. The Chicago Board Options Exchange and the International Securities Exchange, for instance, wanted to see a rollback of the pilot so that fewer options traded in pennies. The move to pennies has reduced displayed liquidity at the inside, making it harder to get large trades done, NYSE Arca’s detractors argued.

Supporters argued that retail investors have gotten better fills in those names trading in pennies and thus the pilot should be expanded. TD Ameritrade, for one, supports expansion of penny names.

Behind the SEC’s approval of the NYSE Arca proposal, the regulator said, was the fact that  "allowing market participants to quote in smaller increments has been shown to reduce spreads, thereby lowering costs to investors."

The SEC did not approve part of the NYSE Arca proposal that would have permitted trading all classes of options on two of the larger exchange-traded funds in pennies.

The penny pilot began in January 2007. It is slated to end October 31. The SEC approval order extends it to December 31, 2010.