‘Fungibility’ Leads to Multiple Options Exchanges

Terry Flanagan

A shift away from floor-based to electronic trading and multiple listings are the primary drivers behind the explosive growth in options trading volumes over the past decade or so, and the concomitant proliferation of U.S. trading venues.

“One of the great things about listed options is they’re totally fungible, except for a few proprietary index products, so you can open an options contract on Philly and close it out on the CBOE, which is different than the futures markets,” said Joseph Corcoran, first vice president and head of government relations at Options Clearing Corp. “In addition to increased volumes, that has also led to a decrease in fees and significant competition among the exchanges.”

The launch of International Securities Exchange as the first fully electronic options exchange cleared the path for the current dozen U.S. exchanges, where floor trading has all but disappeared.

“There was a lot of skepticism at the time about whether ISE could be successful,” said Corcoran. “Of course, we all know it was, and after that happened, a lot of the other exchanges moved from floor-based trading to an electronic trading model, and the vast majority of options volume is now traded electronically.”

He added, “If you’ve been to an options exchange with a floor, there really isn’t a lot of activity on the floor these days anymore.”

Unlike futures exchanges, which have vertically-siloed models including clearing, U.S. options exchanges acts purely as trading venues, with the OCC providing clearing. OCC itself is owned by five exchanges—Chicago Board Options Exchange, International Securities Exchange, IntercontinentalExchange’s NYSE Amex Options and NYSE Arca Options, and Nasdaq OMX PHLX.

“One of the reasons why the big exchange holding companies start different options exchanges is to offer different market models,” said Corcoran. “The focus on competition among the exchanges is technology, speed, and fees, which have really had a big impact on industry volumes.”

For example, NYSE Arca Options uses a price-time priority model versus the more traditional pro-rata/customer priority model on NYSE Amex Options. Both markets operate a hybrid platform offering open outcry and electronic trading.

“It’s a way for the exchanges to distinguish themselves among their clients, and it broker dealers the opportunity to choose different execution venues and different ways to have their customer orders executed,” said Corcoran.

U.S. options exchanges launched in the past few years include International Securities Exchange’s Gemini (August 2013), Miami Options Exchange (December 2012), Nasdaq OMX’s BX Options (June 2012), and CBOE’s C2 (October 2010).

BX Options is geared towards retail order flow. As with Nasdaq Options Market and Nasdaq OMX PHLX, market makers are the principal liquidity providers.

ISE Gemini relies on the same market structure as ISE combined with a pure maker-taker pricing model.

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