The Chicago Board Options Exchange (CBOE) has voiced its strong opposition to a proposed ban on flash orders in the US listed options market, but industry opinion appears to weigh against it.
Numerous small firms and four major market participants – exchange groups Nasdaq OMX, NYSE Euronext and the CBOE and retail broker TD Ameritrade – responded to the consultation on the ban by industry regulator the Securities and Exchange Commission (SEC), which closed on 9 August 2010. Of these, only CBOE was strongly opposed to the proposal, with the others in favour.
The proposal to remove the exception that allows flash orders in equity and listed options markets was originally made on 18 September 2009, following public criticism of the practice by US politicians and regulators.
Flash orders typically display unfilled orders on a venue that can be executed at the national best bid offer price, to a select group of market participants. These participants have the chance to fill the orders in a matter of milliseconds, before they are routed elsewhere to be filled or withdrawn. The purpose of the order types is ostensibly to add liquidity to a market.
However, it has been argued that this information could be used by firms specialising in high-frequency trading to trade ahead of an order, and as the orders are not displayed on the US consolidated tape, that they create uneven access to best price data. US Senator Charles Schumer wrote to the SEC on 27 July 2009 asking that it prohibit this activity based on these concerns.
The SEC originally requested comments on the ban for 29 November 2009. Of the 93 respondents, the SEC noted that 63 supported the ban, 12 were against the ban and 9 were against the ban on listed options.
The latter were specifically based on the differences between equities markets and the options markets operations and costs. There is no regulatory cap on the fees charged by listed options exchanges for accessing best displayed quotations, unlike the $0.003 cents per share cap imposed on equity markets by Reg NMS. Some respondents raised concerns that removal of flash orders could lead to higher access fees in the listed options market.
The SEC then asked for further comment for the period to 2 July 2010, extended to August 9 2010 to address the issues around listed options.
William Brodsky, CEO and chairman of CBOE, wrote in his firm's submission to the SEC that, “the proposal is unwarranted for the listed options market and would affirmatively harm investors as well as competition between exchanges”.
“We further believe that the fee cap proposal is a red herring with respect to flash orders and that the proposal is unsupportable on its merits for the listed options market with or without adoption of the fee cap proposal,” added Brodsky.
He pointed to differences between the equity and options markets, saying that “The options market is a quote driven market with hundreds of thousands of options series, most of which are constantly changing due to changes in the price of the underlying instrument” making it very difficult for an options exchange to display the national best bid offer price continuously and thereby making a mechanism that sought out the best bid offer price advantageous to the customer.
In contrast Janet Kissane, corporate secretary for NYSE Euronext said in its submission, “While the industry supports various market structures and trade allocation schemes, the overall framework of the options market incorporates certain long standing principles: limited guaranteed allocations for principals, exposure of customer interest before crossing, and representation of trading interest in the disseminated market to maintain priority.”
On this basis she asserted that continued use of flash mechanisms “will move the US markets away from a robust price discovery structure towards a more fragmented, European style market characterized by off-exchange negotiation.”