Market-makers for US options have grown increasingly frustrated with trading volumes remaining flat over the past five years, despite rapid growth in the number of exchanges.
While the number of exchanges has expanded to 14 (with potential for another to open up soon), the number of market-makers has dropped dramatically from about 60 to just 15.
Last week, Interactive Brokers announced it would shut down its options market-making business globally after 15 years of operation. Chairman and CEO Thomas Peterffy explained: “it’s been painful for me to see it deteriorating in the last few years.”
There has been some consolidation among exchanges as well, with CBOE acquiring Bats Global Markets and ISE becoming part of Nasdaq. However, they have remained separate entities and are not consolidating into one another.
Market-making is increasingly impacted by the fragmentation of liquidity across exchanges, according to Joy Rosenstein, head of equity options at Fidessa, the launch of a new exchange has not boosted liquidity or trading volumes.
“What it did was took a tiny portion from the parent exchange to that new exchange. It’s not like [new exchanges] made ISE so much more volume, it just meant ISE volume might be diluted between ISE Gemini and ISE Mercury,” said Rosenstein.
This has significantly frustrated market-makers that have to be present on all of these exchanges to touch the market-flow.
Steve Crutchfield, head of market structure at the Chicago Trading Company, noted in a comment letter to the SEC: “In recent years… the population of market-makers on multi-list trading floors has dwindled drastically. With absent robust market-maker participation, trading floors become order crossing venues devoid of price discovery.”
This point is echoed throughout the business in which, due to Reg NMS, an order must be displayed on all exchanges to get the best price. Not a bad rule, but fragmentation of the market has made it more difficult.
Crutchfield added: “We also…request that the SEC consider the larger market structure impact of approving any new trading floor. Approving the Proposal would open the floodgates for every options SRO to open empty ‘trading floors’ in disused office space… engendering serious fragmentation of liquidity, imposing significant new costs on market making firms by obliging them to staff every floor or incur large opportunity costs, and harming investors by facilitating ‘venue shopping’ by firms looking to internalize order flow at the expense of price improvement opportunities.”
The fragmentation in liquidity is also creating further complexity for exchange fees for market-makers. To those users who complain about the fees, exchanges are unrepentant.
Andrew Lowenthal, senior vice president, business development at CBOE, said it’s a “highly competitive business. The market will dictate fees that exchanges charge… We have boundaries that can’t be changed, and we’re in constant contact [with customers] on what we can charge.”
This isn’t a new user complaint. Back in 2014, seven market-making firms, including CTC, Susquehanna, and Wolverine, filed a comment letter to the SEC regarding NYSE Amex’s “Customer Best Execution Auction” fee (CUBE) or so-called “break-up fee,” stating it would lead to internalisation of orders and “hamper traders (primarily MMs) from competing in auction crosses.” They stated this could lead to a “decline in the execution quality of options overall on all exchanges.” They added this kind of cross clearing eventually hurts the customer due to wider spreads.
For the full article look out for the upcoming issue of The TRADE Derivatives