Regardless of trading being based in the pit or upstairs, someone is going to be making markets in those options. The only difference is that they will not be on the floor. What do you think makes AMMs show tighter spreads? It's not lower cost of trading, it's the competition for unsophisticated flow that can be arbed on delta. If a large portion of the market participants are interested in complex orders or if most of the flow is tied, AMMs are not interested (enter an order for something delta-neutral into COB and see how tight the resulting markets are). If there is significant amount of vega risk that's much harder to exploit, AMMs are not interested (look at anything far OTM or longer tenor). Some products tightened when moved into the AMM world and some products actually widened. In the US, single name options in many specific areas have gone illiquid and de-facto spreads have widened. Bring sx5e options on your Bloomberg terminal and tell me if those spreads look tight (or any major European index) - that market has been fully electronic for a while. PS. Personally, I'd love for all of the markets to go electronic, since trading voice is a pain. But I don't really expect much of an improvement over the current state.
The actual bid/ask spreads in the SPX are very tight, if you are able to quote it in the pit or shop it upstairs first. The reason you see wide quotes on the screen is because there is a very limited number of firms allowed to quote the options electronically. When I was on the floor, it was limited to one firm at a time who could actually send quotes. The SPX employs a modified Hybrid system, different from the SPXW. The SPXW has multiple quoters so the displayed market is much tighter. I've been seeing SPXW back month quotes displayed very tightly lately, .20 wide for options under 7, which would equate to .02 wide in the SPY. The SPX has been very successful and the pit traders have a great deal of influence. The exchange charges each one of them a great deal of money to be there. I think the CBOE sees the tremendous institutional volume and believes that may be because of the pit. They are loathe to take the chance of changing what is successful. The real cost of trading the SPX is the cost of the licensing fee paid to Standard and Poors. I pay far more in exchange fees to cover this cost then in commissions to trade the product.
So you agree that actual markets are unlikely to get much tighter if market makers go electronic? That's the argument I am trying to make It's true. A lot of people are used to the process and the access to the institutional size liquidity (well, at least I am) and it's the sort of thing that's easy to lose and hard to gain. Another factor is that with the CSA process being debugged, the OTC trading in vol is making a comeback. I would venture that at least 50% as much root-time vega trades OTC as it does on exchange, especially if you include non-vanilla flow. Since every exchange out there has a few failed "OTC to exchange" ventures in their past (like variance futures), it's hard to justify messing with something that could move back to that realm.
Yes, I agree. I think you would see the disseminated quotes tighter, but the actual real markets will remain the same.
If disseminated quotes get tighter because of electronic trading, the increased transparency should attract more order flow, which in turn should reduce the risk for all market participants. This should lead to narrower spreads of the actual markets. Those are the second order effects of electronic trading which the preponderance of evidence supports.
Why would they limit the number of firms who can quote electronically? This makes no sense to me. What am I missing?
Any idea who the primary market-makers/mass quoters are for the SPX and SPY? I'm referring to the 1st principal MMs who's bid/ask markets everyone else "piggybacks" and joins. The Susquehanna's and Optiver's of the world.