This panel was charged with looking ahead at the equity options market.
The players:
- Chair: Howard Kramer, Partner, Willkie Farr & Gallagher
- Ed Boyle, Board of Advisors, Options City Software
- Frank Hatheway, Chief Economist, NASDAQ OMX
- Kurt Eckert, Principal Wolverine
- Jason Stamer, Manager, Business Development, MEB Options
Question: Are we in the right options market structure?
Boyle: Markets are always an evolutionary process. The markets aren?t perfect, nor will they ever be. Options are still a fairly young product, with a majority of the evolution happening within the last 10 years.? In 1999, with multiple listed markets, that?s when the first really competition started. Exchange models were different in how they serviced the community. Changes comes in three waves: demand of participants, regulation, and communication.? ISE drove electronic trading, which resulted in an explosion of volume and innovation. We need to ask if all these changes have been good? What do we do going forward to work with upcoming changes?
Question: There is stealth regulation in options market with Reg NMS. How is that operating?
Kurt: Reg NMS in options is basically managing trade-throughs in lit markets. At the firm level, it?s managed by looking at consolidated feeds, making sure you don?t post or trade though another price. It?s not an issue so much in options, because routers had been analyzing data before it was sent to the markets, so you didn?t need a large amount of trade-though protection, it was inherent in the market.? The issue is that there is no industry standard consolidated tape.
Frank:? Have you had a chance to see if Reg NMS has an effect on options market? Spreads tightened, VIX went down, etc., but a more sophisticated analysis shows it didn?t have much of an impact, nor did we expect it to. What now? Reg NMS has bred many order types in equities, but what does it mean for options with regard to exchange systems for order types, etc? As it becomes more sophisticated in options, what you wind up with are big questions.
Question: There are now 13 options exchanges, with the possibility of more.? Have we gotten to a point where its best to have that many exchanges? How does this benefit participants?
Boyle: A saturation point ? there is and isn?t. The order protection rule keeps it a fair playing field, but providers barriers to entry. It?s too expensive for average broker-dealer to connect to multiple exchanges. We need to look at exchanges if segmentation is good. The orders at the exchanges need to get into a transparent world. It?s a more competitive environment, with less control for smaller participants.
Question to Jason. I tend to agree with Ed. The market infrastructure is highly efficient. The problem is with infrastructure and scalability challenges. It?s the cost of connecting to these exchanges, keeping certifications that the exchanges require. Infrastructure will end the amount of exchanges rather than seamlessness of structure.
Eckert: Due to consolidation, the liquidity providers have consolidated down to a handful of firms.? The largest people on that side of the business are larger than the exchanges, when you look across all the exchanges. Yes, you can add a new exchange, but you may have a situation where liquidity providers decide not to provide liquidity there because they are already doing it in other venues.
Hatheway: If you take a higher level view of these issues around segmentation, it depends on how many niches you can carve. There are retail, institutional, and professional communities.? The other thing that comes in is a question of services, full services, trading center, having more to offer regarding economy of scale dimension. You can end up with a lot of different platforms that cater to multiple participants.
Question: Electronic trading has lowered trans costs, upped trans speed, etc., but has increased risks to markets. Take Knight, the flash crash, etc. This will fall on firms. How are you mitigating risks?
Eckert: We have so many internal safeties, they are too numerous to count. The concept of risk management for a trading firm, it didn?t start the day the market access rule went into effect.? Unless an exchange could guarantee us some safeties, we wouldn?t route to that exchange.
Question: There is talk about kill switches at exchange or firm level. Is that appropriate?
Hatheway: We’ve done a lot of analysis about exposure that is generated by individual firms, and you can get big numbers quickly from firms you wouldn?t expect.? We?ve had kill switches for a ling time. Are exchanges the best place to have this? Probably not because of fragmentation. We have a public perception issue. If a broker fails, the public won?t get too concerned about it. If an exchange has a solvency issue, how would the public react to that? What might that do?
Question: Is it time for the SEC to put out concept release on options market structure?
Boyle: They are always beneficial. The problem when they come out is that they have to look at the market in the broad sense. Its hard to distill it down. You have to look at it from the business model that you’re choosing. Their tie would be better spent looking at regulation we have today.
Hatheway: They don?t have the bandwidth.