Options brokers raise concerns about penny-quoted market
Last Update: 7:39 AM ET Oct 20, 2006
NEW YORK (MarketWatch) -- With the options industry gearing up for a test of a sweeping change in the way options are traded, one group of options brokers raised a number of concerns about the plan Thursday.
The concerns of members of the Options Committee of the Securities Industry Association include questions on the impact of quoting options prices in penny increments on the ability of retail investors to obtain priority over professional traders in a penny-quoted market.
The group also called for the pilot to run for 18 months, far longer than other industry officials have said that they expect it to.
The group also thinks that quoting options in penny increments will likely limit the so-called depth of liquidity for options. In the stock market, what was called "decimalization" broke the pool of shares available to be bought and sold from 16 groups into 100. The group said this will occur to a greater degree in the options market. Options are currently quoted in 5- and 10-cent increments.
A pilot program, mandated by Securities and Exchange Commission Chairman Christopher Cox earlier this year, is due to begin in late January. The pilot will include options on 10 stocks and three exchange-traded funds, including the heavily traded options on the Nasdaq-100 Trust, better known by its ticker: QQQQ.
The pilot itself is widely seen as inevitable, but, in a letter Thursday to Erik Sirri, director of the SEC's division of market regulation, the SIA's Options Committee raised a series of concerns about the pilot. A spokesman for the SEC wasn't available to confirm that the letter was received Thursday, or respond to it.
The letter, obtained by Dow Jones Newswires, was signed by Christopher Nagy, who chairs the committee and is managing director at brokerage TD Ameritrade Holding Corp. (AMTD). Other members of the committee are executives at brokerage firms and options market makers of various sizes, including Goldman Sachs Group Inc. (GS), OptionsXPress Holdings Inc. (OXPS), Charles Schwab Corp. (SCHW) and Citadel Investment Group LLC.
Nagy couldn't be reached for comment, but one committee member who asked not to be identified said that the letter was written because its members feel that the SEC has not given their concerns fair consideration.
The regulators were approached by the committee in July, with specific recommendations about the options that should be included in the pilot. Many of those recommendations were ignored, he said.
"The committee wants to be engaged in the process, the committee wants to be influential in the transition to pennies, and the committee definitely sees itself as a good, broad representation of the industry," he said.
Though the letter states upfront that the "SIA strongly supports the call of the commission for such a (pilot) program," it does outline a list of concerns.
These include the assertion that quoting options prices in penny increments "is likely to result in less aggressive quoting and lower-quality executions for investors" in less liquid options classes; the fact that the list of stocks chosen to be included in the pilot is weighted heavily toward more liquid options; and the fact that investor interests might also be well-served by allowing for additional strike prices in certain options instead of just quoting in penny increments.
Strike prices, the price at which an option contracts allows investors to buy or sell a particular stock, currently increase in $2.50 or $5 increments, and many in the options industry argue that the SEC should allow some options to be issued with strike prices of $1 increments.
Supporters of the transition to penny quoting view it as a way to narrow the spread between the price buyers and sellers of options can offer - thus improving the price offered and benefitting options traders, they say.
It also is seen as a way to put an end to the practice of payment for order flow in the options industry. Payment for order flow is a system in which brokers are paid by options market makers for routing their options orders to one exchange over another. Penny quoting will eliminate the process, it is thought, because market maker profits - and therefore the payments - will diminish.
A number of options brokerage firms, though, including some that are on the SIA Options Committee, currently benefit from the payment for order flow system. Those firms stand to lose a notable percentage of their revenue from options trading - something they say allows them to keep trading costs low - if the practice of payment for order flow ends.
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