Bloomberg News

Nasdaq OMX’s BX Options Exchange to Copy Electronic Market Rules

May 02, 2012

Nasdaq OMX Group Inc. (NDAQ:US) will use rules from another electronic options market it owns to hasten the introduction of its third equity derivatives venue, the company told regulators.

Nasdaq OMX BX Options will utilize trading rules from Nasdaq Options Market, the firm told the Securities and Exchange Commission in a rule filing that didn’t say how the venue will differentiate itself from other markets. The exchange, slated to start trading in late June, must win approval before it can be introduced.

“The exchanges have built their market models around attracting different segments of participants and order flow,” Andy Nybo, principal and head of derivatives at New York-based Tabb Group LLC, said in a phone interview. “Are exchanges going to continue to slice and dice that order flow to get a smaller piece of a growing pie?” The challenge, he said, is to offer new features “instead of replicating existing models.”

U.S. options trading reached a ninth-straight annual record last year, according to data compiled by Chicago-based OCC, which clears equity derivatives transactions. Options exchanges construct trading rules and pricing models to entice different participants, sometimes targeting individual investors, market makers or brokers interested in buying or selling a larger number of contracts at one time.

Exchange companies such as Nasdaq OMX, NYSE Euronext, CBOE Holdings Inc. (CBOE:US), each of which have two options exchanges, have used their markets to give investors more choice. Nasdaq OMX, at least initially, may use the same rules while offering different pricing in its new market.

Less Effort

“This approach minimizes the technical effort required for existing BX members to begin trading options on the BX Options market,” the exchange told the SEC in the filing. “BX Options will differentiate its market by offering innovative features in the future.”

BX Options told regulators the exchange will initially have the same rules as Nasdaq Options Market, introduced in 2008 as a so-called maker-taker market that pays the suppliers of bids and offers and charges those executing against them. The largest options markets at the time had what are called pro-rata models that guarantee a portion of incoming trades to market makers quoting at the best price and don’t charge retail investors or institutions such as mutual funds for executions.

Since January 2007, when options exchanges were allowed to quote products less than $3 in 1-cent price increments, venues with more traditional pricing began shifting to a hybrid structure of pro-rata and maker-taker rules, depending on the contracts and their daily trading activity. There are now nine options exchanges, compared with four -- all with trading floors -- in 1999.

2008 Purchase

BOX Options Exchange, which received SEC approval last week as a so-called self-regulatory organization that can run its own venue, is surrendering the license Nasdaq OMX will now use. Nasdaq OMX bought (NDAQ:US) BSE Group, which operated the Boston Equities Exchange, for $61 million in 2008. It didn’t acquire BOX, which was using the same license and will shift to its own this month, according to BOX Chief Operating Officer Anthony McCormick.

BOX focuses in part on retail trading through its rules and the introduction in 2004 of a system that seeks to give customers better prices than those publicly available.

U.S. options volume decreased 4.7 percent to 335 million contracts last month from a year ago, according to data compiled by OCC. The Chicago Board Options Exchange was the largest individual market with 27.1 percent of total trading, followed by Nasdaq OMX PHLX with 18.2 percent, OCC said. While Chicago- based CBOE Holdings’s two exchanges had the highest share of all trading, NYSE Euronext (NYX:US) and Nasdaq OMX in New York had a bigger portion of options based on stocks and exchange-traded funds and excluding indexes, the OCC data showed.

‘Dispersion’

“With electronic markets, there’s been a dramatic change in the industry,” Jerry Markham, professor of law at Florida International University in Miami, said in a phone interview. “It opened trading up to competition from all sides and you can see it in the dispersion of volume on options exchanges. Others I’m sure want to go after that.”

A debate has stretched on for decades about whether increased competition among exchanges at the expense of liquidity, or orders at multiple prices, on individual venues outweighs the advantages of consolidating demand in a single location with fewer rivals, Markham said. The SEC has discussed the topic in reports including its Special Study of 1963 that set the framework for rules over the next generation and in papers on fragmentation in 2000 and equities market structure in 2010.

Arbitrage

Exchange companies benefit from offering multiple markets that compete for buy and sell requests as investors spurred by lower trading costs submit more orders. They also gain from transactions by firms seeking arbitrage opportunities because of price differences across venues. Exchanges earn market data revenue from quotes and trades as well as fees from brokers or other firms that pay to place their computers closer to those that match trades at the venues.

The International Securities Exchange, introduced in 2000 as the first all-electronic venue, plans to start a second market this year. Nasdaq OMX will be the only company with three U.S. equity derivative markets once BX Options begins trading. Miami International Holdings Inc. also plans to start a venue.

“With 12 exchanges planned, you really need to create a better mousetrap to attract flow,” Nybo said.

To contact the reporter on this story: Nina Mehta in New York at nmehta24@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net


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Companies Mentioned

  • NDAQ
    (NASDAQ OMX Group Inc/The)
    • $43.86 USD
    • -0.11
    • -0.25%
  • CBOE
    (CBOE Holdings Inc)
    • $55.33 USD
    • 0.58
    • 1.05%
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