Are The Days of Cheap Options Commissions At An End?
....continued from "A New Front In The Penny War"
Payment For Order Flow Vs. Maker-Taker
The growth of the retail options business has long been subsidized by taxes on liquidity providers. The revenues from these taxes are then passed onto the order flow providers in the form of payment for order flow. While this practice is highly controversial, it has also contributed to the massive reduction in retail options commissions over the past decade.
However, the onset of the maker-taker pricing structure is beginning to threaten that tenuous arrangement. Squeezed to the breaking point by shrinking spreads and increasingly punitive taxes, liquidity providers are migrating to exchanges that offer rebates.
At the same time, these maker-taker exchanges are also charging fees to customers that take liquidity from their markets. This has lead to a bitter debate over who should shoulder the burden for these fees and rebates. Many in the options business think that it's finally time to raise retail commissions and educate retail customers about the value of reduced bid/ask spreads.
On the flip side, retail brokers argue that their customers are extremely price sensitive, so raising commissions is simply not an option.
The Great Dichotomy
This dichotomy was on full displayduring the Penny Panel at the recent Chicago Trading Forum. When the inevitable question about fees was posed to the panel, the variety of responses revealed the deep split in the options business.
"Exchange sponsored payment for order flow is just a fee structure that benefits the order flow provider," said Pete Bottini, EVP of Trading and Customer Service for retail broker OptionsXpress. "Of course, there are many people here who would argue against that structure. However, the reality for us is that we can't raise our rates, So if we go from receiving a rebate of fifty cents per contract to paying a fee of fifty cents per contract under the maker-taker model, that's a dollar that we have to find a way not to pass on to our customer."
Perhaps not surprisingly, Scott Morris, CEO of the Boston Options Exchange (BOX), took the opposite view. As the second options exchange to embrace the maker-taker philosophy, BOX has made a commitment to rewarding market makers for providing liquidity:
"I think that all of these fees and credits are going to have to be passed on to the customer," said Morris. "The only way that many of these retail firms are going to be able to maintain their cost structures is to pass these fees along."
Bastiaan van Kempen, CEO of Optiver US and the sole liquidity provider on the panel, expressed a view that is slowly gaining traction among market makers:
"What this all comes down to is the pure education of the retail customer," said van Kempen. "The retail customer needs to learn that the two or three cents they are saving through reduced bid/ask spreads more than compensates for any minor increases in transaction costs.
These comments elicited a few heated questions from the audience. Randy Frederick, Director of Derivatives for Charles Schwab, immediately chimed in against those who suggested increasing customer transaction costs:
"There is not going to be any way that the brokers are going to be able to pass these fees directly to the customers," said Frederick. "None of us in the retail brokerage community have the opportunity to raise our prices. Over time, prices come down, they don't go up. That's not going to change now. I can also say that, from a retail perspective, customers hate maker-taker. I don't think that any of us are going to be able to set up a structure where we can pass on that taker fee to the retail customer and then educate them that, although they are paying more in commissions, they are actually getting a better price. Customers just don't want that."
Who Is Right?
Judging by the diversity of opinion on display in Chicago, this conflict over fees has only just begun. As more exchanges embrace maker-taker, this dichotomy is only going to get worse.
So who is correct in this debate? At the end of the day, it doesn't matter. The reality of the markets will resolve this issue long before these two warring sides can ever come to an agreement over fees. Retail brokers may eventually find themselves with an entirely different cost & revenue structure than they had just a few years ago. At that point, we'll see which firms can survive without the crutch of payment. We'll also see which firms have become so dependent on payment that they simply cannot function in a maker-taker environment.
If you're a retail customer that is worried about higher commissions on your brokerage bill, take a deep breath and relax. After all, commissions aren't the only cost of doing business in the options market. The next time that you are upset about paying too much in commissions for your trades, stop and look at your entire execution cost (including the spread). Chances are that you are actually saving money in the long run.
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