In July 2010, it was reported that NASDAQ OMX Options finished the month with a combined 25.88% U.S. equity options market share – the highest in the industry. NASDAQ’s Executive Vice President of Transaction Services, Eric Noll, sat down with JLN’s Jessica Titlebaum to discuss developments on their PHLX and NOM platforms as well as in the Options space and why he considers his new position at NASDAQ like a homecoming.
Q. As Executive Vice President of Transaction Services at NASDAQ, what are some of your responsibilities?
A. My responsibilities include what I call operating the day-to-day exchange platforms. I have primary responsibility for and operate what we call NASDAQ Classic (the NASDAQ Exchange, the Philadelphia Stock Exchange and the Boston Stock Exchange.) I am also responsible for the International Derivatives and Clearings Group (IDCG), and the NASDAQ Futures Exchange. Underneath the NASDAQ Exchange is the NOM platform and in Philly, the Options platform. I am also responsible for the European Derivatives effort.
Q. What are some of the challenges you face in this role?
A. I think there is a multiplicity of challenges out there for us, as NASDAQ, and for everyone in the financial services space. On the equity side, we are tasked with solving the market structure issues that have arisen from May 6th. I think that NASDAQ has done a pretty good job trying to define the new circuit breaker system – how to roll it out, how to install it, etc.
The May 6th challenges have concentrated all of our attentions on what is the appropriate interaction on orders to market makers and how we ensure continued price discovery in times of panic volatility. These challenges are away from what I call the day-to-day competing market centers.
We are also talking about creating real market maker incentives and eliminating stub quotes so that we have actual market makers engaged in market making on our platforms.
We also have a lot of equity markets that compete in our space; Dark pools, ATS’s, ECNs… all struggling to gain as much order flow as they possibly can. The challenge is to bring pricing functionality and execution quality, all the things necessary to continue to compete in this marketplace.
Q. The NOM options market share is jumping around a bit. What are your plans for increasing market share?
A. We operate two options markets. One is the PHLX, which has had remarkable success this year and we have grown our share significantly since we moved our order routing system and order allocation system to a price time pro-rata system, maker taker model.
Pricing has also moved to a maker taker-pricing model, so you are rewarded for posting liquidity and you pay for taking liquidity. That has allowed the PHLX to be inside the NBBO. That has acted like a magnet for additional order flow. Market share is in the 20’s now and combined with NOM we are at about 25% market share.
NOM is a classic price time maker taker model. It appeals very much to customers looking for a very fast price time priority system. They look to NOM at various times to route order flow. We are always looking at that model to see how we can grow it and to appeal to a larger subset of investors.
A lot of the market share on a platform like NOM is dependent on where customer interest is trading. A price time maker taker exchange does better when investor flow and investor contracts are concentrated in a few names and a few strike prices, because it is a very efficient way to discover price and liquidity. On the other hand, if customer interest is spread out over many names and strike prices, different models will be better at providing liquidity. It’s not only a function of pricing but of where investor interest is going.
Q. Can you tell me a little bit about dividend trades?
A. I would call them dividend capture trades as opposed to dividend trades. The International Securities Exchange (ISE) has taken a position against dividend trades, but I don’t believe dividend trades really mislead investors. Different people have different costs to operate in the marketplace meaning the expenses of clearing trades, exercising options, holding stock, margin costs, buying and selling securities, etc.
Some people don’t exercise their options to buy stock and earn the dividend for various reasons. One may be that it’s not cost effective for them to exercise the option, hold the stock, earn the dividend and then sell the stock and reposition themselves in the option if they own the option for a specific reason ahead of time. There are fees associated with every step of that and those expenses may be higher than others so they do not exercise their option and don’t capture the dividend.
Other market participants have lower costs. They might want to capture the dividend, meaning their costs of buying the option, exercising it, owning the stock, collecting the dividend and then selling out of the stock are below the dividend rate they would collect. So they will engage in this behavior to capture as much dividend flow as they can.
To me, that is what makes a market. If everyone felt the same way about a security at all times and had the same cost base for securities at all times and everyone had the same investment horizon as everybody else, no one would trade.
Q. What do you think of BATS Trading moving into the Options space?
A. Clearly BATS has demonstrated itself to be an effective competitor and I have a great deal of respect for their management team. They are an additional challenge to us. We clearly monitor what they are doing in terms of pricing, market share and functionality. And we are always looking to make our platforms more efficient.
The options space is becoming increasingly competitive. You don’t just have our marketplaces but you have the CBOE, BATS, Boston Options Exchange (BOX). And now Chicago is going to introduce C2, CBOE’s second options license. Then you have new potential competitors like Miami that we haven’t seen yet. The industry will continue to compete with functionality, pricing and order priority models.
Q. Why do you think options are experiencing growth at this time?
A. The options space in particular has always been one of those industries that I thought should have grown faster earlier. There are some historical reasons why it wasn’t successful earlier but I think it is catching up on its promise. Options are an innovative product, which struggled early on in their appeal to investors. The OCC and the OIC have done a great job educating investors on how to use them for hedging and income generation. As the options market has greater acceptance, it has higher volumes and attracts competitors. So it is capitalism at its core.
Q. What do you see next for this space?
A. What will be interesting is product extension. We have had a great deal of success in equity options like in Philly, the semi-conductor index that has options on it. We’ve seen the CBOE’s growth with the VIX suite of products. I believe we will see other exchanges ask how they can leverage the components of an option to provide additional value to investors.
Q. How did you get into this industry?
A. I was a graduate student at Vanderbilt University and getting my MBA at Owen School of Management. My mentor and professor there is a fairly well known professor in finance and derivatives theory named Hans Stoll. I had several classes with him and he introduced me to the then-CBOE chairman Duke Chapman, when I was graduating. Duke hired me at the CBOE as a strategic planning associate, which is how I entered both the exchange business and the derivatives business.
Q. So you moved to Chicago?
A. I moved to Chicago and worked at the CBOE for three years before I was recruited to the Philadelphia Stock Exchange. In some ways, my job today is a homecoming because I worked at PHLX in business development and strategic planning. I was there for about a year and then joined Susquehanna International Group where I spent over 15 years.
Q. What did Hans Stoll teach you as a mentor?
A. When I went to business school, I did not know there was anything like a derivative or an options market or a futures market. I was fascinated by it and Stoll taught me the mechanics of the industry. He also got me interested in the microstructure, which was an esoteric topic at the time but it is not now. For example, how do buyers and sellers meet one another, what is the ideal way to maximize liquidity and price discovery, what are the fair ways to operate markets and exchanges? He also operates the Financial Research center where they would bring in people from the NYSE, NASDAQ, CBOE and the Chicago Mercantile Exchange.
Q. Do you have a failure or success in your personal career that you have learned something from?
A. One experience that taught me something was when we moved our PHLX order priority model from a traditional, successful specialist system to something different. It was a risky move and we could have gotten it wrong.
I have the benefit of a very talented staff and they pushed to move down this road and I went with it. It has been successful and taught me that taking good, calculated risk is good for us and good for our business. Will we always get it right? No, we will make mistakes but we have to remember the benefits of looking to innovate.