Future All-Electronic Markets: BOX a Definite, Eurex Investigating The International Securities Exchange was the pioneer, but soon it will not be the only all-electronic options exchange in the United States. The Boston Options Exchange (BOX), a fully-automated options market jointly owned by the Boston Stock Exchange (BSE), the Bourse de Montreal and Interactive Brokers (IB), expects to make its debut next year. Moreover, Eurex, the all-electronic German-Swiss derivatives market, is devising a strategy to throw its hat into the electronic U.S.-options ring. BOX, which initially plans to list the 250 most actively traded U.S. options, has already filed its market model and rules with the Securities and Exchange Commission. Pending regulatory approval, the market could be operational by the second quarter of 2003. Eurex, meanwhile, is currently weighing two options for breaking into the American-options arena: launching its own all-electronic options market or partnering with an existing U.S. exchange. The owners of BOX will each play a key role in the launch and evolution of the exchange. The BSE will act as BOX's regulatory-services provider; IB, a direct-access broker, will be responsible for the exchange's market design; and the Bourse de Montreal will provide the technological infrastructure -- including the core trading engine -- for BOX. BSE officials, through an exchange spokeswoman, decline to comment on BOX. But Rosanna Teti, vice president of business solutions and information technology at the Bourse de Montreal, says that BOX will employ a competitive market-maker model. Instead of having a single specialist, she says, BOX will have multiple market makers trading each option listed on the exchange. "It's a first-in, first-out model ... where, basically, the best trade wins," says Teti. The Bourse de Montreal, an all-electronic, Canadian-derivatives exchange, employs a very similar market model. Moreover, Teti says, the exchange just converted from a floor-based market to a fully-automated exchange last year -- so it is very familiar with both the business and technology challenges the BOX will face. "The challenge to building a trading system for this type of model is that there is no limit, in terms of number of market makers. So the challenge, technology-wise, lies in capacity," she says. "Market makers, as you know, have the obligation to continuously provide two-sided markets, and you can imagine how many quotes they (might generate) in the span of a second. We tackled that challenge for Montreal, but the challenge will be greater at BOX." In fact, Teti says, the Bourse de Montreal expects BOX to be "10 times bigger" than its own exchange, in terms of volume. The BOX will use a customized version of NSC, the Bourse de Montreal's trading engine, to handle that volume. The Bourse de Montreal licenses NSC from ATOS Euronext, the IT arm of the pan-European, all-electronic Euronext exchange. But Teti says that Montreal is tweaking the system for BOX, to both ensure that it can handle large volume and certify that it is in compliance with the exchange's specific rules for options trading. In addition to the trading engine, the Bourse de Montreal will also provide networking and connectivity solutions to BOX. "We will be responsible for the whole infrastructure, beginning to end, that is necessary to operate an electronic market," says Teti. BOX, she says, will also use an open application-programming interface that will allow exchange participants to electronically link to the market via the front end of their choice. Meanwhile, a Eurex spokesman says the derivatives exchange is currently talking to its U.S.-based customers to understand their options needs. It is possible, he says, that Eurex will launch a standalone, all-electronic U.S. options exchange, using the internal matching engine through which it currently trades European-equity options and futures contracts. But it is equally possible that Eurex will partner with an existing U.S. stock exchange to establish a niche in the American-options market. Eurex's review of this market, says the spokesman, is still in its "very early" stages, and the exchange is not leaning in any particular direction. However, it is certain that Eurex will try to leverage its existing derivatives contracts, regardless of which venue it chooses to make its U.S.-debut. "Our powerful indices and options contracts in Europe are the main focus we would also have for the United States," the spokesman says. While Eurex has not yet finalized its strategy, the BOX is now merely awaiting approval from the SEC. Exactly when the commission will make its ruling on BOX remains unclear, but Teti says Bourse de Montreal is planning to deliver all of its technology to the new exchange before the end of the second quarter of 2003.
Electronic Revolution Pits ISE vs. Floor-Driven Exchanges The all-electronic International Securities Exchange has experienced tremendous growth since its May 2000 debut, forcing its open-outcry-based competitors to usher in a new wave of automation. But the CBOE, AMEX, PCX and PHLX are counterattacking the ISE with their own major technology projects. "This will probably be a small ripple leading to a larger splash leading to a wave, which, hopefully, will wash over the other exchanges," says Phil DeFeo, describing the potential evolutionary path of the Pacific Exchange's soon-to-be-launched PCX Plus trading system. But what the PCX aspires to attain, the all-electronic International Securities Exchange has already achieved. In fact, DeFeo, the chairman and chief executive officer of PCX, may as well have been describing the impact that the ISE, launched in May 2000, has had on floor-based, U.S.-options markets - sans the "hopefully" part. Offering customers cheaper costs, faster executions and open access, the ISE started out slowly, grabbing only 2 percent of the overall options market in its first four months of existence. However, from August 2000 to this August, the ISE increased its market share by roughly 22 percent (see chart), leapfrogging the PCX and the Philadelphia Stock Exchange (PHLX) in the process. Options Markets: Then and Now CBOE AMEX ISE PHLX PCX 8/2000 RANK 1 2 5 4 3 Market Share 40.58% 30.51% 1.97% 11.50% 15.43% 8/2002 RANK 1 2 3 4 5 Market Share 28.60% 24.90% 23.47% 12.29% 10.75% Source: Options Clearing Corp. "To some regard, the traditional exchanges maybe took the ISE a little too lightly," says Tony McCormick, vice president of equity options at Charles Schwab's Schwab Capital Markets Group. "But by virtue of them coming in as a new entrant, with a different model that was efficient and transparent and readily accessible, (the ISE) put a lot of pressure on the existing floor-based markets to adapt and become more competitive." Indeed. The ISE fostered change in many ways, such as by implementing a balanced-fee structure that led to increased volumes and heavy competition for order flow. Ultimately, those factors fueled the elimination of fees charged to investors - or customers of broker/dealers - at all five U.S.-options markets. Michael Juneman, assistant vice president in charge of floor operations at Timber Hill - a market making firm that makes markets on all five U.S.-options exchanges - says that the ISE deserves most of the credit for the death of customer-transaction charges. "The customer fee being brought to zero was a direct result of competition. If a customer has an opportunity to trade for less at Exchange A than Exchange B, he will go to the cheaper exchange every time," he says. That said, while acknowledging the success of the ISE, floor-driven U.S.-options markets are not about to back down. Rather, the CBOE, AMEX, PCX and PHLX - responding to the growth of the ISE and recognizing the threat posed by other potential all-electronic entrants - are now fighting back with major technology initiatives of their own (see sidebar: "Future All-Electronic Markets: Boston Options Exchange a Definite, Eurex Investigating," at www.wallstreetandtech.com/story/WST20020927S0001). PCX POWER PLAY Daniel Friel, chief information officer of the ISE, says that the ISE separated itself from the pack by taking the best the existing auction markets had to offer and combining that with technology. "The ISE has a primary market maker that actually acts like a specialist," he says. "So it's kind of an open-outcry market ... except the specialists are all entering their quotes electronically." Timber Hill's Juneman says that one thing that distinguishes the ISE from its competitors is the fact that it provides all of its market makers with the ability to electronically post bids and offers. The floor-driven markets, he says, must move more towards that model if they expect to gain ground on, or just keep pace with, the ISE. Today, the ability to electronically post two-sided markets is reserved for the specialists at the AMEX, PHLX, CBOE and PCX. But Juneman says that whereas each of these floor-based markets has a single specialist driving a two-sided market per option, the ISE has the equivalent of 10 specialists posting bids and offers for each issue listed on its exchange. "When an order comes in (to a floor-based market) and push comes to shove and the market makers don't like it, they look the other way," he says. "The (specialists) are then left there holding the bag, so oftentimes their size doesn't compete with the size the ISE can put out - because the ISE allows 10 (primary) market makers to post a bid and offer for (each option) it trades." The PCX, in response to requests made by firms like Timber Hill, has developed an electronic-trading system dubbed PCX Plus - an application that will not only allow ordinary market makers on the floor to enter two-sided markets but will also enable market makers in remote locations to post bids and offers. The rules for PCX Plus were submitted to the Securities and Exchange Commission in June, and the PCX hopes to receive the green light to launch the system before the end of January 2003. In the past, says an exchange spokesman, only PCX specialists - known as Lead Market Makers (LMMs) - were authorized to electronically enter two-sided quotes. But, after PCX Plus goes live, any PCX market maker will have the power to electronically enter bids and offers from any remote location. Moreover, via PCX Plus, both LMMs and competing market makers will have the ability to enter two-sided markets for options traded in any pit across the exchange's floor. In other words, if you are standing in one crowd but want to electronically post a bid and an offer for a contract traded in a pit on the other side of the floor, you will be able to do just that. "Our objective was to maximize the potential profitability of all our constituents on the floor ... . So a market maker in one pit (will be able to) make markets in another pit," says PCX's DeFeo. This added functionality, he says, should enhance the price discovery and liquidity on the floor by lifting restrictions on what options a market maker in a certain crowd can and cannot trade. But the remote posting capability of PCX Plus may be the one functional enhancement that could separate PCX from other floor-based-options exchanges. Market makers that own or lease at least one seat at the PCX will be able to use PCX Plus to electronically enter bids and offers from any location across the world. The exchange spokesman says that the PCX expects to attract substantial off-floor liquidity through PCX Plus - including order flow routed by specialists based on the floors of other exchanges. The PCX will attempt to reel in remote market makers by offering a range of incentives, including low-cost entry. A market maker that chooses to enter bids and offers remotely, says the spokesman, will be able to trade eight PCX issues for the cost of one seat on the exchange - $20,000. Moreover, he says, remote market makers will also have more freedom to pick and choose the options they want to trade than their floor-based counterparts. "If you're a competing market maker on the floor of the exchange, you have a primary assignment. You've got one crowd, and you're expected to trade 75 percent of your volume in that one crowd ... But if you are making markets remotely, you (will be able to) trade any issue you want, and it will cost you a lot less money," says the spokesman. Still, despite the incentives that the exchange is tying to its remote option, DeFeo does not think that PCX Plus will ultimately replace PCX's floor. People will continue to use the floor, he says, to reap benefits from its price discovery and liquidity - but it will not be the only venue for trading. CBOE READIES HYBRID FOR ACTION William Brodsky, chairman and chief executive officer of the CBOE, says that floor-based markets were automating their environments long before the rise of the ISE. However, he concedes that the all-electronic market has effected change and enhanced the competitive landscape. "There is no question that the ISE had made an impact ... . I think competition is very good - it gets our juices going. And a lot of the things that we've done reflect how the ISE has changed the (market) model," says Brodsky. The development of a new trading system is one of the ways in which the CBOE is answering the ISE. Like the PCX, the CBOE is building an application that will give floor-based market makers the ability to electronically post bids and offers. But, in contrast to the PCX, the largest U.S.-options market currently has no plans to allow either its specialists or market makers to enter two-sided markets remotely. Today, explains the CBOE's Brodsky, only a designated primary market maker (DPM) - the exchange's equivalent of a specialist - can electronically post bids and offers for CBOE options. But following the debut of the exchange's so-called Hybrid Trading System - which is expected to go live in early 2003 - all of the exchange's market makers will be able to electronically input two-sided quotes.
Electronic Revolution Pits ISE vs. Floor-Driven Exchanges "What we're doing is allowing our floor-based market makers to electronically post (quotes) ... . But the requirement is, if you're going to quote in a particular option, you have to have someone in the crowd who is representing those quotes," says Brodsky. Since the CBOE has "around 1,000" regular market makers, he says, exchange participants should be able to see a lot more quotes - and have access to more size - after the hybrid system is launched. But the CBOE chose not to emulate the remote component of the PCX Plus system for a couple of different reasons. Firstly, says Brodsky, the CBOE did not want to devalue the cost of a seat on the exchange. And secondly, the exchange believes that it will have more than enough floor-based market-maker support. "If the (PCX) had (enough floor-based) market makers, they'd probably do the same thing we are. But they don't have that many people to begin with, so they're trying to find, obviously, other ways to get people involved," Brodsky explains. Enabling electronic entry for market makers will actually be the third major component of the CBOE's hybrid project. In May of this year, the exchange rolled out a dynamic quoting system that allows investors to see real-time prices and size for all CBOE options series. Subsequently, in July, the exchange released Large Order Utility (LOU) - a point-and-click trading application designed to provide customers with the power to instantaneously execute large-size orders. LOU, in addition to providing automatic executions, also has the ability to price-improve orders by exposing them to the liquidity on the floor, says Brodsky. Timber Hill's Juneman says that his firm is looking forward to the third phase of the CBOE's hybrid project, but gives LOU mixed reviews. LOU, he says, does provide the "point-and-click" access the CBOE was previously lacking, but is not the best system for executing large-size orders. PHLX AND AMEX: AUTOMATING THE AUCTION PROCESS The PHLX and the AMEX, like their open-outcry rivals, are adding automation to their open-outcry environments. The PHLX has filed a proposal with the SEC to launch a new trading system that will, for the first time, empower its market makers to electronically change a bid or offer posted by a specialist. William Morgan, the PHLX's chief information officer, says he is not certain when the SEC will rule on the exchange's proposal. But he says that after the new system is implemented, a market maker will be able to "electronically change a PHLX quote" via a handheld PC. The ISE, Morgan says, has, in the past, held an advantage over floor-based markets by providing a more "level playing field" to all of its participants. Specifically, he says, the all-electronic market gained an edge not only by making its data transparent and accessible but also by allowing all of its market makers to electronically enter two-sided quotes. But the PHLX, he says, will soon offer the same type of openness that has propelled the ISE. "Market makers used to have to verbally request a market be changed by a specialist. Now that, of course, has changed because we're going to give the market maker the ability to change a quote directly," says Morgan. That said, however, the PHLX currently has no intention of offering its new system to remote market makers. Interestingly, the exchange has already built a remote-competing-specialist system for its equities floor - but extending that application to the options floor, at this date, seems unlikely. Morgan declines to comment, but a source at the PHLX says the exchange would run the risk of angering its existing specialists if it extended electronic-posting privileges to market makers operating away from the floor. "That would change the (options) allocation process ... (and) that's a very sticky subject," the source says. The AMEX, meanwhile, is developing a new options-trading system that will completely replace its incumbent platform. "We've created an electronic auction that will be a part of our marketplace," says Michael T. Bickford, senior vice president in charge of options at the AMEX. "Rather than yelling out bids and offers with their voices ... a market maker or specialist who is inputting a price into an auction will do so electronically." While declining to specify the third-party-technology vendor that is building the new system, Bickford says the electronic platform should go live by the second or third quarter of next year. The system, he says, is flexible, and could potentially accommodate remote specialists - but the AMEX has no plans to offer it outside of its floor at this time. Still, while insisting that the AMEX remains a "big believer" in the traditional floor-auction marketplace, Bickford says the system has been designed with an eye on the automation trend. "We understand that bricks and mortar may some day become a thing of the past, so we've built (our options system) with the flexibility ... (to) ultimately take it off of our trading floor - if need be," he says. While conceding that the ISE has taken some business away from the AMEX during the last couple of years, Bickford says that the all-electronic upstart has also taken market share away from the CBOE. Indeed, while AMEX's overall slice of the options pie has narrowed, it has actually inched closer to the CBOE since May 2000. CONSOLIDATION OR EXPANSION? Despite the fact that all of the floor-based markets are in the midst of significant technology upgrades, consolidation is a real possibility in that group of exchanges. "We're in a business that demands scale and efficiency and to the extent that you can achieve that, or you have too many exchanges delivering that, you have some that will combine or some that will (become extinct)," says the PCX' DeFeo. "We've been around for 122 years, and I expect that we will be around in the next 100 years, but not if we don't change as the markets change." A source at a large options market-making firm also sees exchange consolidation on the horizon. "We already do a lot of business with the ISE ... . So I would have a hard time believing, two or three years from now, that there is still going to be six (options) exchanges," this source says. Schwab's McCormick, on the other hand, thinks there will be a mix of electronic expansion and floor-based consolidation. The existing open-outcry markets will not try to merge with one another, he says, but will seek out alliances with electronic entrants. " I think the (floor-based exchanges) might try to partner and become the vehicle for electronic entry guys ... . I could see Eurex, maybe, forming (a union) with the Pacific or something like that," says McCormick. When the ISE looks to the future, says Friel, it does not "discount" floor-based markets - but is cognizant of the fact that it will have to fight a "multi-front war" against electronic models similar to its own. But will the next wave of electronic-options markets try to mimic the ISE, or attempt to offer clients something innovative and unique? It's difficult to give a definitive answer to that question, because the Boston Options Exchange - an all-electronic market that has yet to get off the ground - has provided precious few details about its market model. But McCormick says that since a new entrant must differentiate itself, it's a good bet that at least one future electronic-options market will try to adopt an ECN-type model. Such a model, he says, would represent a significant departure from the traditional options market - which requires market makers to maintain two-sided quotes and sizable liquidity. "Will the SEC allow someone to open an environment where there is no requirement to put up a two-way market with any size? I don't know," says McCormick. "But a (new entrant) may (attempt to) look more like a central-limit-order book, with price and time priority built into it." ISE Senior Vice President of Business Development Bruce Goldberg says that, to be successful, every new entrant - whether floor-based or electronic - must figure out what added value it brings to the customer. "Is a new exchange going to provide greater liquidity, better quality markets or faster execution? Those are the questions that every new entrant has to ask itself," he says. Meanwhile, the AMEX's Bickford predicts that the only new exchange entrants in the industry will be of the electronic variety. Since there are now four floor-based markets and one electronic exchange, he says, there are more opportunities for new electronic entrants to differentiate themselves. "If you're a new competitor looking to come into the marketplace, you've got to look for where your opportunity is," he says. "The electronic (options) marketplace is less staked out ... (and), from a cost basis, it's definitely easier and more cost efficient for new entrants to put together an electronic exchange."
Is there any chance that the allowable spreads on options will move from .05 and .1 to .01? I understand that MMs make their ching on the spreads, and most often will not wish to, and certainly should not be forced to make a .01 market, but considering that options have a delta <1, overcoming a 20 cent hurdle to simply break even must be a major wet blanket on paper flow. I cannot speak for other market participants, but as a flat price spec. my own volume in options would go up by a factor of at least 10 if we could post and act on narrower spreads in the liquid strikes. O.
Don't know the answer to the spread question. However, things are looking good. The latest press release and 4 major new investors in the exchange. Below is a mail I've rec'd from a contact at the exchange: "After many months of discussions, BOX received the green light from SEC staff last night to proceed with the official filing of the regulatory documents supporting the creation of this new US equity options market. The proposed BOX Trading Rules and related documentation will shortly be available in the Federal Register and the period for public comment has commenced. The BOX website (see below) has been updated to include the following new information: * four new BOX LLC shareholders (see http://www.bostonoptions.com/ove-ope.php) * details on the BOX Price Improvement Period (PIP) including a demo/simulator (see http://www.bostonoptions.com/pri.php) * the proposed BOX Trading Rules and the BOX "Statement of Purpose" filing with the SEC (see http://www.bostonoptions.com/box.php) The web site has also been updated to provide information on upcoming road show presentations planned for early December 2002 and we confirm our target live date for the second quarter of 2003. I have also attached this morning's press release. "
the press release: If the attached PDF doesn't work try this link: http://www.bostonoptions.com/pdf/BOXPressReleaseUS.pdf
Here is something: Looks like the penny increment is only good for MM during the PIP period. Looks like the public will be able to participate to an extent.
Is it necessary for the end client's broker to start the PIP process, or can any of the market makers start the PIP for an incoming order by having say resting/hidden orders a .01 within the nbbo? The examples and text seem to suggest that the process is always started by the end client's broker, in which case trading through a broker who actively manages a large book in the series would seem to benefit traders. O.
Part 1 of 2 Part Post: I am the General Counsel of IB and I have worked on the BOX rules personally for the past two years. This is to clarify some misperceptions about the BOX rules and to compare the BOX rules to how the option markets are NOW, under current rules. If you compare BOX to a hypothetical, utopian option exchange that does not exist and will never exist (and which big market making firms would never trade on), BOX of course falls short. However, if you compare BOX to what we actually have today, BOX is far more fair than the existing exchanges and will offer traders like you the opportunity to participate and compete in a way that you cannot now. I am happy to discuss this further by email or phone and my contact information is provided below. I really would urge the traders on this forum to consider how things are now on the existing exchanges. Maybe BOX does not have everything you want, and maybe it has some things you donât like. But without BOX, there will be no progress at all and you will be stuck with the existing system. Try to think about this when you are commenting because otherwise you may throw the baby out with the bathwater, so to speak. Anyway, here are some specifics: 1. On any existing exchange, if a sophisticated small option trader or firm wants to be a member, there is a substantial purchase or lease fee and even then, you can forget about being the primary market maker. On BOX, by contrast, any properly registered firm or person can be a market maker and there is no lease or purchase fee, only transaction fees. There is no primary market maker or specialist who controls the prices on the book and all market makers (and customers) compete on a level playing field in strict price time priority. If you want to use the PIP process and compete in penny increments, sign up as a market maker. Indeed, this is one reason why the rules are designed as they are â if there is no incentive to become a market maker, there will be no professional liquidity and the SEC would never approve the exchange. BOX has far fewer perks for market makers than any other exchange but we have to have some or the exchange simply will not be viable and we can all live with todayâs lousy system forever. 2. The other reason that the PIP takes place in pennies, but the general order book is in nickels and dimes is because of capacity and bandwidth constraints, primarily at OPRA. BOX would not be allowed to go straight to pennies for everything because if all exchanges did so, OPRA could not likely handle it now. When the industry improves its infrastructure and everything goes to pennies, this issue will go away. 3. On BOX, all market makers or customers can post prices instantly and cancel orders instantly. There is no primary market maker who can hold up posting your order or canceling it or who can âleanâ on it when the market moves against you. There is no $1.00 cancellation fee designed to punish you and your brokerage firm for trying to change your price in a moving market. Indeed, the existing option exchanges are considering rules that â in addition to charging you $1.00 -- would prevent you from canceling your order for ten seconds. This would guarantee their ability to lean on your orders and trade them only when they have gone against you. BOX has no cancellation fee and no cancellation period. Better still, BOX has no clerks or other terminal operators who work for the specialist and who may not have been able to cancel your order because they were âbusyâ while the market ran against you.