Making Sense of Market Structure

Terry Flanagan

In the U.S. equity market, with internalization, dark pools, and 11 exchanges, an order may have many different stops before it’s executed. The increasingly circuitous nature of an order’s route adds to the risk of information leakage and impaired execution quality, putting the onus on institutional investors and other asset managers to ensure their alpha is preserved.

A similar fragmentation has settled upon the options market.

“The explosion in the number of exchanges and the opportunity to route orders based upon numerous pricing permutations has completely changed the dynamics of how traditional buy-side firms look at The Street,” Jason Lichten, director of equities and listed derivatives trading strategies at Wolverine Execution Services, told Markets Media. “The buy side is looking at technology spending and they’re utilizing firms that maintain their technologies to the highest degree.”

Lichten focuses on the growth and distribution of WEX’s electronic listed options and equity trading business. He is applying his experience in U.S. equity market structure to educating the buy side on the complexities of options trading and sourcing liquidity.

Jason Lichten, Wolverine Execution Service

Jason Lichten, Wolverine Execution Services

“My goal is to be able to go out and speak with the buy side, educating them on how our team of experts can help them better understand the options markets as we know them today,” he said. “If I were to look at 12 to 24 months down the line, I’d like to see a new level of transparency provided to the buy side on the complexities of options trading with the goal that WEX is a trusted partner in that education process.”

Options market structure is equally if not more fragmented than the equity markets. There are 12 exchanges, with the potential for additional expansion. “The market and pricing structure on each exchange makes it extremely difficult to fully understand what’s going on,” Lichten said. “That’s where the market structure landscape begins to shift a bit and how we, as a firm, are taking a more aggressive approach in educating the buy side.”

In a July 2014 paper, John McPartland, senior policy advisor in the financial markets group of the Federal Reserve Bank of Chicago, advocates creating a new, optional non-cancellable term limit order type—for example, Buy at 12, good for 4 seconds or Buy at 12, good for 4/10ths of a second.

“There is no apparent reason this optional order type could not be used in a fragmented market structure where any number of trade allocation methods are in use,” said McPartland.

Disappearing liquidity is even more prevalent in the options market than the equities markets, so speaking with the buy side about the fragmentation in the U.S. equity options market and how to improve execution quality is a priority for WEX.

“One of the biggest issues that I’ve seen with the various firms I have spoken with is the idea of ‘disappearing liquidity’ and not understanding how each of the 12 options exchanges operates,” Lichten said. “You have 12 exchanges with different fee structures, 12 different protocols, and 12 different market data feeds. WEX is able to bundle this information together as a simplified solution for listed options and helps mitigate a tremendous challenge for the buy side.”

WEX has invested “a significant amount of money in developing technologies to help our customers compete with the most technologically advanced firms,” Lichten said. “We have implemented a solution that significantly increases our percentage of fill rates.”

WEX has been “incredibly successful in penetrating the sell side and select buy-side accounts since its startup in 2004,” he said. “We are focused on how we, as a firm, can educate the buy side on options market structure, where disappearing liquidity is a significant issue.”

Featured image via Petr Ciz/Dollar Photo Club

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