Traders Plead With Regulator to Overhaul U.S. Options Auctionsby
Market-making firms and industry groups ask SEC for fixes
Critics say auctions remove liquidity from normal trading
Traders are urging U.S. regulators to fix a part of the options market that some blame for contributing to the last five years of stagnant trading.
Auctions, which mainly match orders from individual investors, may have reduced competition during normal trading. The relative attractiveness of auctions could be reducing liquidity in the options market as market makers cut their efforts elsewhere during continuous trading.
“Corrective steps need to be taken to safeguard the high level of competitiveness that has served the options market for over 40 years very well,” a group of market-making firms wrote in an Aug. 5 letter to the Securities and Exchange Commission.
The letter followed the New York Stock Exchange’s decision to change fees on its options auction mechanism earlier this year, a move the SEC has temporarily suspended.
The options exchanges started using auctions to get market makers bidding on the same orders, thereby lowering costs for investors. Market makers like trading with individual investors because their orders are viewed as safe. Typically an individual investor doesn’t have more information than a market maker.
Firms also argue that differences in exchange fees and rebates can give some market makers an advantage over others.
Outside of auctions, market makers have widened the spread between their bid and offer prices -- which helps dictate how much money traders make -- to compensate for higher regulatory and technology costs.
Wider quotes can make trading less appealing for investors, potentially causing volumes to shrink. The average spread between the bid and ask prices for listed options has climbed over the past few years, according to data from Hanweck Associates and Tabb Group.
Auctions are becoming more popular at the same time that spreads are widening. Auctions accounted for 14.3 percent of volume on U.S. options exchanges last month, up from 11.8 percent a year earlier, according to the letter from the five market-making firms: Susquehanna International Group, IMC Financial Markets LLC, Spot Trading, Wolverine Trading and Integral Derivatives.
“The industry is looking for the SEC to opine on the structure of these auctions and how they should operate,” said Andy Nybo, a partner at research firm Tabb Group. “Auctions provide a wealth of benefits to the industry, but the rules need to be transparent and fair.”
Florence Harmon, a spokeswoman for the SEC, declined to comment.
Volumes have barely moved in the options market over the last five years. In the first seven months of 2016, average daily volume for equity and index options was 1.8 percentage points higher than a year earlier, according to Options Clearing Corp. Excluding index options, which are nearly all traded on the Chicago Board Options Exchange, the increase was 0.2 percentage point.
Citadel LLC, CTC LLC, Optiver US LLC, Group One Trading LP and trade groups the Securities Industry and Financial Markets Association and the FIA Principal Traders Group have also urged the SEC to examine fee structures in auctions. NYSE, while defending its fee change with regulators, is also asking the SEC to review auction levies “on all options exchanges with an emphasis on the market as a whole,” according to a letter it wrote to the SEC.
Bats Global Markets Inc., which runs two U.S. options exchanges, will become the latest market operator to offer auctions in November when it starts a mechanism on its EDGX exchange. The company still needs SEC approval. Bats also said it will provide incentives for market makers to offer quotes throughout the trading day in an attempt to narrow the spread between the bid and ask prices.