BOX Delays PIP Pricing Suspension

Terry Flanagan

The Boston Options Exchange (BOX) found at least temporary reprieve Sept. 21 for the dramatic fee and credit hikes it instituted for participants in its Price Improvement Period (PIP) auction, eight days after regulators suspended approval of the new fee schedule to evaluate it further.

The BOX took advantage of the ability for self-regulatory organizations to appeal a suspension delegated by Securities and Exchange Commission (SEC) staff, essentially nullifying the suspension until the agency’s commissioners can address the matter, a process that can take several months.

“We’re back to the pricing we were offering before it was suspended,” said Tony McCormick, BOX’s CEO.

The controversy began Aug. 1 when the BOX filed with the SEC to raise both the credit given to parties initiating orders in PIP and the fee for those responding with bids or offers to $0.75 per contract from $0.30 per contract. The new fees apply to options classes that are not quoted in pennies, and penny classes where the trade price is equal to or greater than $3.

The BOX noted in its filing that the change was “designed to provide all BOX market participants an additional incentive to submit their customer orders to the PIP and allow those orders the opportunity to benefit from its potential price improvement.” Customer orders are those from retail and institutional investors.

Comment letters subsequently submitted by Citadel, IMC Financial Markets and the International Securities Exchange each opposed the fee and rebate hike. A common criticism was that the $0.025 per contract transaction fee when added to the $0.75 per contract responder-fee results in a total charge of $1 per contract.

A party initiating a transaction, on the other hand, receives a credit of $0.75 per contract, and if that party also responds with a bid or offer it can internalize the transaction for much less than at competing exchanges, since the credit and fee cancel each other.

“Thus, the order internalizer only will be charged a transaction fee that ranges between $0.10 to $0.25 per contract (depending on certain volume thresholds),” said the ISE in its comment letter.

The ISE and other firms commenting argue BOX’s pricing schema is much more attractive to broker-dealers looking to internalize trades than parties competing for orders. As a result, they say, it’s unlikely to improve the prices that customers—broker-dealers representing retail and institutional investors—receive compared to the best bid or offer, as the BOX claims. Those broker-dealers typically pass on savings to their customers.

In a comment letter filed Sept. 9—just four days before the SEC suspension was filed—the BOX countered that most transactions on the exchange are initiated by market makers who are independent of participants acting as agents for a customer orders. “As such, BOX sees no basis for the criticism that the initiating participant can offset fees with credits,” the letter says.

Commenters warned that BOX’s “discriminatory” pricing catered directly to broker-dealers looking to internalize trades. The BOX notes in its response, however, that the percentage of contracts executed by participants initiating the transactions actually fell in the first month of the new pricing, to 36% in August from 38% in July.

In addition, competing bids and offers among transaction responders appeared to have increased, contrary to naysayers’ arguments. The BOX notes that “average price improvement per contract in PIP transactions increased from $0.0062% in July 2011 to &0.0087 in August 2011,” providing customer transactions with $7.3 million in price improvement.

“TD Ameritrade clients received over $600,000 in price improvement over the prevailing national best bid or offer” in the month of August,” wrote Christopher Nagy Managing Director Order Strategy at TD Ameritrade. “TD Ameritrade believes this customer experience on the BOX strongly indicates that healthy and robust competition exists within the PIP.”

TD Ameritrade’s letter was dated Sept. 12, the day before the SEC suspended the BOX’s pricing schema. The commissioner’s final decision, of course, remains to be seen. The BOX notes, however, that its fees and rebates are completely transparent, while many of the other exchanges, including the ISE, structure payment for order flow (PFOF) between their market makers and broker-dealers providing customer orders. In fact, the BOX says, anecdotal evidence suggests the inducement credit it provides may even be less than what many firms receive through PFOF.

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