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Market Overview

The Opposite Sketches: The Pay-To-Make Exchanges

The Opposite Sketches: The Pay-To-Make Exchanges

Last week, the maker-taker exchanges was touched upon: Nasdaq OM, NYSE Arca (formerly Pacific Stock Exchange) and BATS. These trading venues offer a significant rebate to liquidity providers (limit orders) and charge a taker fee to liquidity sources.

For names like Bank of America (NYSE: BAC), the rebate/fee is close to half the option bid/ask spread. This has drawn in many new market maker algorithms trying to take advantage of these economics.

The new breed of exchanges that charge liquidity providers is a experiencing a fairly recent expansion. It all started in 2009 when the Boston Options Exchange (BOX), in an attempt to grasp some relevance in the options market, decided to create a fee schedule whereby liquidity providers were charged a fee and liquidity takers were provided a rebate. This just seemed to be a desperation play by BOX.

The BOX was always that one weird exchange with Price Improvement (PIP) that had no customer-priority; maybe someone could get hit on an order here and there. It was just that strange old exchange, akin to a strange old uncle. But in recent months, the BOX has regained its relevance.

It was at the forefront of the reverse rebate taker-maker model that both Nasdaq BX and C2 (CBOE’s weird brother) have adopted. The latter went through its transformation from a full-fledged maker-taker model to a taker-maker model for equity-options (index and ETF options still have the maker-taker model).

The transformation of the C2 to a partial taker-maker model was the result of the exchange not being able to gain significant market share in the maker-taker space. It was a somewhat under-the-radar move in that some traders were not aware of the fee change and received retro-active fee adjustment penalties.

 In this environment where these marketplaces are desperate for volume and earnings, option exchanges will find a way to adapt in order to grab a hold of market share and trading fees. Therefore, traders must be constantly checking exchange fee schedules, either through RSS feeds or via the exchange’s website.

The Little Three’s Relevance

The taker-maker exchanges are small with respect to market share (OCC website for today shows roughly five percent of US equity option market volume). But they offer opportunities for traders to get into a position by taking AND receive a decent rebate. Sometimes they join a maker-taker exchange showing a large market order with the hopes of getting hit first.

Sometimes traders actually want to grab a piece of that maker-taker order even though it is showing a large size that may affect the volatility in the strike or expiry’s curve.

Regardless of reason, the smaller taker-maker order offers an opportunity to get into the trade while capturing an effectively reduced price via the rebate (as of last week’s Interactive Broker’s website, basic equity option penny-pilot taker-maker rebate/fee: BOX ($-0.18/$0.82), Nasdaq BX ($-0.32/$0.40), C2 (-$0.18/$0.55)).

Other interesting situations occur when option markets tighten up in wider names and these exchanges are showing bids/offers with replenishing quantities. This is an indication that some market maker needs to get out of some risk and will pay anything to do so. And it might not be straight forward; it might be a setup.

At any rate, the evolution of exchange fee structure economics come into play as spreads get tighter and volume decreases. This is not a static situation and we, as traders that want optimize profits, must be attentive to the moving parts in the options space in order to do so.


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