At the end of the last day, one might expect light attendance at the last panel.? Not so with this one.? The crowd was enthusiastic and started right away with questions for the group.
The players:
- Chair: Barry Metzger, Chief Operating Officer, optionsXpress
- David Adent, Director, Equities AVT, Barclays
- Timothy Brennan, VP, NYSE Euronext
- Patrick Hickey, Head of Market Structure, Optiver U.S.
- Ben Londergan, Chief Executive Officer, Group One Trading
- Mark Malueg, Senior Equity Options Trader, Susquehanna
Audience: How are you coping with decreasing profit margins?
Adent:? We make up for it in volume, with weeklies, etc.
Malueg: Seconded that.
Londergan:? Added that higher volume, and a greater capability for risk control have both helped. The intro of wysiwyg trading platforms has also helped greatly. Getting out of a position is easy now compared to how it used to be. We?re getting more efficient with trading, and better systems and technology allow you to capture more volume.
Hickey: Innovation has helped, too.? Weeklies in particular. There are just better trading opportunities.
Audience: Why are there options market makers?
Brennan: They provide liquidity and orderly markets.
Hickey: Having market makers goes back to the structure of the market itself. In equities, you have several thousand underlyings, but in options, you have 400,000. There are just not enough orders out there to help drive what each of those securities are, so market makers fill the role to provide fills and prices.
Brennan: Without market makers who have specific obligations, you would not have anything to trade against.
Adent: The upside to competition is deep, liquid markets, significantly more so than in the underlying.
Malueg: With market makers providing continuous quotes, you can value your portfolios all the time.
Audience: Given the bad press on flash crash, etc., one charge is the market makers are there until you need them. How do you respond to that?
Brennan: Market makers are there at all times. They are required to be. They have obligations to be there.
Londergan: At the end of the day, the exchanges and regulators have pushed for more speed and automation, but you leave yourself with a marketplace where market makers have huge exposure at any time. If you want more speed and automation for customers to interact instantaneously, you have a situation where every market maker will do this if he has the capability to bail out along the way. If you want instantaneous access, it?s not always safe for market makers.
Brennan: You?re at market risk, gap risk, etc., which is easier to manage these days.? Biggest risk for market makers is operational risk. We?ve seen that lately, and managing operations risk is the single biggest burden we have as market makers, followed closely by compliance risk. That ticks down to actual portfolio risk.
Adent:? Regarding the stocks and underlying, we move our quotes with those quotes. When flash crashes happen, we get hurt because we miss our quotes. We?re actually the front line for that kind of movement, and most at risk.
Regarding the operational risk issue.? Do you have methods to manage that?
Brennan: Given automated trading, computers do the same thing over and over again, and you can blow up a firm in less than 20 seconds.
Hickey: Risk limits by exchanges are not harmonized. Managing operational risk becomes a burden across all the exchanges, instead of managing it holistically. It?s a burden.
What other issues have you seen that have changed over the last 10 years?
Malueg: It?s all electronic. There are fewer people condensed in a single space and they communicate better. It used to be a person in the pit and another person put an order into the pit, and you could think about it.? Now you need the computer pre-programmed to respond. The thinking happens in advance rather than on the spot.
Brennan: The skill set of traders has changed a lot.? You see junior traders coming up through computer science and financial engineering.
Have these changes been good for clients?
Hickey: Definitely. You used to have one exchange trade one security, and no other market makers could join. With ISE you had multiple market makers posting multiple quotes with multiple sizes.? Prices came in, sizes multiplied. It?s been fantastic for end-user retail client
Brennan: What is often overlooked in the introduction of electronic trading is that we went to pro rata. In order to compete, you get much more liquidity on the screen than before. Now you have the tightest deepest markets.
Malueg: It?s good for retail, but its tricky for institutional. Size isn?t always there.
Adent: That?s a big risk. Getting swept on our quotes.
Discuss pro-rata vs. pure price-time. Does pro-rata make for better liquidity?
Brennan: In a pro-rata allocation, you only get the percentage of the quote you are, as the quote grows, you have to continually quote larger and larger. Liquidity begets liquidity. I?m not saying what works best, but what I am saying is that this is often overlooked. Had there not been enough liquidity, there wouldn?t have been as much interest in the electronic markets.
Londergan: The biggest problem with price-time is there is a disincentive to join when a big trade comes in. You tend to have small size at the top of the market.
Hickey: Price-time does give incentive to price improve.? If you are there first, the incentive is to improve price to get more of the market.
Is there a point where there is to much trading between market makers?
Hickey: there could be. There has to be someone else introduced to the picture that has a different set of expectations than market makers do. Trades between market makers are treated just like any other trade, as long as there are no customers ahead of me trying to trade at the same price.
Are there enough market makers now? Is the barrier to becoming a market maker too great?
Brennan: It?s an interesting time. You have to wonder how a new entrant is coming in given current conditions. But we don?t have fresh eyes.? Someone could see things from a different perspective and change things completely. Its up to innovation.
Hickey: There are incentive schemes out there to get bigger than we are, but the question is how to get bigger. It?s hard
Londergan: The ability for anyone up here to impact the outcome of the question is very low. All of our biggest risks are rule changes, regulatory changes, etc. It?s difficult to impact that outcome.
Adent:? The old market making model is dead and its never coming back. There is nothing you can do about that.
What do you think about 12 options exchanges?
Hickey: We?re not on all of them, and the differentiator is expense.? Connectivity, membership, etc., If you get there and there is no trading, then how do you cover that expense?
What impact has weeklies had?
Hickey: It?s had a huge impact. Look at volume in other asset classes, and then you look at options product weeklies is 17% of all volume. They?ve made a huge impact on the industry.? It gives more opportunity to spread, for risk management, have tighter spreads, its been a real positive experience for us.? That being said, dailies, hourlies, are not so popular, but its helpful to have the conversation.
Brennan: We have minis coming out soon.? It opens up new opportunities to get new investors.
How much more significant have legal and compliance costs become?
Hickey: For our firm, we have these costs, but we want to define them so that, if need be, we can put them back into the spread that we charge market participants. What we want is clarity and certainty. If we don?t know that, what price should we be putting up? What size should we be putting up? Clarity and certainty is tantamount to us. And we really don?t have a lot of that right now.
Adent: We have little regulations that customers never see. Even though things are automated, we still have to do it.? A lot of things that are really low level that you would never think about that were dealing with all the time.
Brennan: There were times when I was market making when I was spending 80% of time on compliance issues.
What are thoughts on single stock futures vs. cash equities for hedging?
Malueg: We don?t really use them. Why not? Liquidity jus isn?t there. I don?t know why not.
Brennan: I was shocked when the short sale rules that were introduced that single stock futures did not take off.? That was a perfect time for that product to take traction, which says that there is either a flaw in the product, or not enough education.
Londergan: We?re a market maker in single stock futures, and it?s used more as a financing transaction or a stock loan transaction. I think the concept is good, but I don?t think the adoption has been good.
Looking to the future and the way market makers compete, what are the biggest factors that you compete on?
Adent: Interacting with flow. The problem with institutional flow has a big impact on the underlying volume. You don?t have that impact with retail.
Brennan: It depends on the market maker and his utility, the scope/scale of the business.? All market makers compete on speed, on being fast enough to not have their idea taken away from them.
As the election looms, are there things that concern you form a business standing?
Brennan: There needs to be more clarity, regardless of outcome. There is way too much confusion.
Hickey: Couldn?t agree more.