ICE Options Exchanges Heat Up

Terry Flanagan

Intercontinental Exchange Group’s U.S. options business, comprised of sister exchanges Amex and Arca, is poised to branch out.

“There are opportunities for us to expand our business around complex orders and electronic auctions,” said Steve Crutchfield, executive vice president and head of U.S. options at ICE. “These are areas where we’ve had a smaller business historically.”

Complex options strategies entail combining trades of call or put options into a options spread with a specific speculative or hedging objective. Complex orders make up a comparatively small part of options trading volume, but the area is seen as one with high growth potential.

Steven Crutchfield, ICE

Steven Crutchfield, ICE

“We have gradually been growing the scope of our complex business over the last couple of years, particularly on the Amex platform,” Crutchfield told Markets Media in a March 14 conference-room interview in the New York Stock Exchange building in lower Manhattan.

“Within the next couple months we will be rolling out an expanded array of functionality” in the complex order book, such as a ‘good-til-cancelled’ offering, Crutchfield said. Customers are testing the functionality, and “we anticipate rolling that out in production, pending regulatory approval, around the first of May,” he said.

In financial markets, an auction has been described as “an electronic means of gathering around the buttonwood tree.” Electronic auctions are an alternative to continuous matching as a mechanism to pair buyers with sellers, and some market participants believe auctions enhance price stability. Crutchfield described his team’s auction initiative as “our biggest opportunity in the short term.”

“There are opportunities for us to expand our business around complex orders and electronic auctions.”- Steve Crutchfield, ICE

On March 6, the U.S. Securities and Exchange Commission published the rule filing for NYSE Amex Option’ Electronic Price Improvement Auction, called CUBE. The proposed functionality is designed to support single-leg auctions for paired orders, which consist of an initiating CUBE order and an accompanying contra order. “That’s technology we already have built and implemented, and it is ready to turn on as soon as we get the green light from the commission,” which could come after a comment period wraps up in late April, Crutchfield said.

“The electronic paired-order auctions, which are typically used for smaller retail-size orders seeking price improvement, has been a quickly expanding area of the business overall,” Crutchfield added. “We’re probably about the largest player among those that have not yet brought an offering in that space. So we’re very excited to bring that forward and to turn it on. I think our clients can expect us to price competitively and quickly become a major player in that space.”

Double Threat

Arca recently had U.S. options market share of about 12%, while Amex weighed in at 10.2%, according to OCC data. That ranked fourth and fifth among 12 U.S. options exchanges; on a combined, overall-volume basis, IntercontinentalExchange ranked third of seven options-exchange operators, trailing CBOE Holdings by about 8 percentage points and Nasdaq OMX by 1 percentage point.

ICE is the only operator with two options exchanges with more than 10% market share.

“We came off a nice, strong 2013, where we were on a combined basis the largest exchange group by market share per equity-options volume,” Crutchfield said. “Market share shifts month-to-month, but we’ve continued a nice, strong trend, particularly on our Arca market.”

“We have been able to demonstrate our ongoing value proposition, particularly for liquidity providers,” Crutchfield added. “For retail orders that are not marketable, that is those retail orders that are seeking to get a better price than the price displayed on the screen, we continue to do very well.”

James Hyde, ICE

James Hyde, ICE

Amex and Arca came under new ownership in November 2013 when Atlanta-based ICE, known for its network of commodity-futures exchanges and clearing houses, closed on its $11 billion acquisition of NYSE Euronext, best known as the owner of the iconic NYSE at the corner of Wall and Broad. Crutchfield indicated the early months of the changeover were seamless, at least as it pertained to the operations of the equity-options exchanges.

“We represent a business in an area that ICE has not focused on historically,” he said. “We don’t see a change in our mandate — we’re very much focused on continuing to provide the best options platform for our customers and grow our business, while rolling out new technologies and new product offerings. That continues, just as part of a different organization.”

Like other options-market operators, ICE is seeking not just to capture market share from rivals, but also to bring in business from retail and institutional equity-market participants who haven’t dipped their toes in the world of puts and calls. To that end, ICE will continue the Thought Leadership Forum, an annual mini-conference co-hosted by the Options Industry Council. This year’s event, the third annual, will be held June 12 at the NYSE.

“It attracts endowments, pension funds, and other folks for whom options perhaps isn’t the easiest asset class to absorb into their product lineup,” said James Hyde, ICE senior vice president and head of business development for U.S. options. “But as this group becomes more educated, options are becoming a bigger piece of their business and portfolio mix, and ultimately of their customers’ experience.”

“As (institutional investors become)more educated, options are becoming a bigger piece of their business and portfolio mix, and ultimately of their customers’ experience.”- James Hyde, ICE

Hyde explained that the primary objective of the Thought Leadership Forum is to debunk the perception that options are inherently risky, and go one step further by showing risk-averse investors that options can mitigate portfolio risk. “They can take risk out of the equation when used properly,” he said.

A key presentation of the event focuses on an institutional options user, juxtaposing recent years’ investment results with options — typically selling covered calls — to back-tested investment results without options. “As folks walk through how they use options in that period of time, the folks in the room who do not use options get a lot out of it,” Hyde said. “That’s been our ‘secret sauce’.”

The forum has gained momentum. “The first year we did this, it was very hard to gain traction and get phone calls back and have pension funds actually want to be engaged,” Hyde said. “As we have shared feedback from the event, it has been easier to get folks to reply and want to be part of it…We work with OIC to get the right people in the room.”

Multifaceted Approach

Crutchfield sees the event as one of many outreach efforts and initiatives that a market operator needs to do to stay competitive. “We’re always looking at opportunities to enhance our offering,” he said. “That can be through acquiring technology, building something homegrown, or finding ways to get eyeballs on screens that route business to our markets. Sometimes it’s in a behind-the-scenes way, where we work with a vendor who’s putting technology on desks.”

Having ICE as a parent company can open doors for Amex and Arca.

“One of the great things about being part of the ICE Group is that they bring their own technologies,” Crutchfield said. “For example, ICE Chat, which used to be YellowJacket, historically has been used more for other asset classes. But is this something we could apply to the equity options markets?”

“ICE has an options evaluation and risk-management system, among other technologies and platforms that w’re exploring,” he continued. “These are things that have been successful on their platforms already, so they are known quantities.”

For the Amex exchange, last year’s change of ownership was its second in a little more than five years. When NYSE Euronext bought the American Stock Exchange in October 2008, Amex had 5.42% of U.S. options volume, ranking fifth of seven exchanges, according to OCC; the better-capitalized new owner improved technology, built a new trading floor, and boosted the options exchange’s market share to about 15% within a few years.

But as they say, a tree cannot grow to the sky. “After we tripled market share, I knew we wouldn’t be able to triple it again,” Crutchfield said. “Options markets have only gotten more competitive…We continue to work to preserve our offering and preserve our market share.”

“In terms of client participation, we”re looking at a pretty similar group and a pretty similar color of order flow to what we’ve been getting over the last several years,” he continued. “Amex is a market which we tailor to be friendly to the retail investor, and to the retail investor’s order flow. Our model on the Amex is to maintain the right incentives and maintain customer priority — we never charge customers for any order on the Amex, no matter how large.”

“On the flip side, what that allows us to do is have an appropriate level of fees for our market-maker participants, who are eager to be members of our exchange because incoming order flow on the Amex has among the lowest adverse selection, or toxicity, in the industry. We’re making the effort to be friendly with the retail flow that liquidity providers want to trade with, and we continue to be a top-tier destination for large retail brokers’ directed flow.”

Crutchfield maintains an active voice in dialogues with options exchanges, market maker, institutional and retail end-users, and regulators. Currently hot topics for the industry include Regulation SCI, an SEC proposal that would require exchanges and other market operators to have comprehensive technology-systems policies and procedures in place; preventing and managing erroneous trades; and market fragmentation.

“We have commented extensively on Reg SCI regarding our concerns,” Crutchfield said. “It is well-intentioned, but I don’t think it’s a coincidence that this happened during a year when a number of things didn’t go so well in our (industry’s) markets…We are watching carefully and waiting.”

“On the issue of errors, we have been a very active participant and supportive of industry efforts to formalize rules across options markets,” he continued. “That can simplify and also improve the ‘state of play’ in terms of how errors are dealt with. Part and parcel of that is, not just how we handle errors when they happen, but how can we enhance the rules to prevent errors from happening. We’ve taken some big steps in that direction.”

The ICE options exchanges are also moving forward with their own safeguards and risk controls.

“One of our top initiatives in the past year has been rolling out our global risk mechanism, which went live at the end of January,” Crutchfield said. “We were the first exchange to go to production with this, which enhances market-maker risk triggers that protect participants by causing market makers to be kicked out of the market if they exceed a certain level of trading.”

The new functionality applies on a symbol-by-symbol basis as well as in aggregate across all symbols, across all servers and matching engines, Crutchfield explained. Additionally, “we cleaned up our obvious and catastrophic error rules back in the fall, which moved forward a standard of adjusting, rather than ‘busting’, trades in every instance where there isn’t a customer involved on the trade,’ he said. “We’re going toward having adjustment be the standard.”

“On the topic of error prevention, I expect the industry will have some robust accomplishments over the next six months, particularly with implementation of the cross-SRO standards on improving on these error rules,” Crutchfield added.

Regarding market fragmentation, “we’re looking to find ways to encourage greater liquidity to be displayed on the screen in options markets,” Crutchfield said. “With the proliferation of electronic auction mechanisms, one could argue that reduces the incentives for market makers to have continuously displayed aggressive quotes on the screen, because that is no longer needed to attract an order.”

“So we are looking at, subsequent to the initial roll-out, adding some incentives to our auction that will reward those market makers who on an ongoing basis provide liquidity aggressively through the normal course of business,” he said. “We’re also looking at exploring some market-structure changes, which could incent the display of additional size to the screen, for all participants…Trying to find ways, in a fragmented environment, to ensure that liquidity is provided effectively to participants who are seeking it, is an important part of our longer-term strategy.”

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