BATS takes a swing at Flash Boys and options growth

Apr 30, 2014

BATS Global Markets has been in the spotlight lately, which has many at the exchange wondering why it had to be the one that was closest to Brad Katsuyama’s trading terminal in New York.

In the wake of the thunderstorm caused by Michael Lewis’ book “Flash Boys,” and accusations that named BATS as the exchange that was part of the “rigged stock market” claim, Jeromee Johnson, BATS’ vice president, head of BATS Options market, says such charges are flat out wrong. Lewis tells the story of Katsuyama, now president and CEO of IEX exchange, how his cash equity orders would route first to BATS and then to other stock markets while he was at Royal Bank of Canada. Such orders would often tip off high frequency traders of a larger order, at which point they would beat Katsuyama’s orders to other stock exchanges and then sell them back to him at higher prices.

That caused Katsuyama and others to call foul, blaming stock exchanges and HFT firms, a charge that Johnson says is simply false.

“It’s not as big deal on the options side as it is on the cash side,” Johnson told John Lothian News, at the Options Industry Conference in Austin, Texas, which is hosted this year by BATS. “It is a big deal on the cash side if you watch 60 Minutes, or read Michael Lewis. But if you actually talk to people who understand the markets, they recognize the fallacy in so much of that argument.”

To Johnson, this uproar over Lewis’ accusations is simply wrong. Markets, he says, have always had participants who move on perceived information about large orders by large institutions.

“The fact is, orders get piece-mealed, sliced and diced, and work their way into the markets in different ways, to different platforms with different latencies,” Johnson said. “And there are folks who will detect a large order and will trade against that information. None of that is new, nor is any of that surprising to the vast, vast majority of market participants who feel strongly there is nothing nefarious going on.”

The Securities and Exchange Commission (SEC) is looking into the matter, as is New York’s state attorney general Eric Schneiderman. But Johnson argues that those looking to curtail HFT in the name of fairness should be careful when talking about limiting or banning practices such as co-location, maker-taker pricing structures, payment for order flow or slowing of trading.

“The commission’s mandate is to foster competition among and between the markets, in addition to making sure we have a fair marketplace,” he said. “And historically they have said that different pricing mechanisms is part of that competition. Do you really want to pull that leg away from what is out there today? And the incentives around maker-taker, the folks who are providing liquidity to that marketplace and contributing to price discovery are getting rewarded. And those who are taking advantage of that price discovery are getting charged. In and of itself, that doesn’t sound like a bad incentive scheme.”

Johnson believes that the issues will be addressed by regulators in the coming weeks and months, and that data-driven studies by the SEC and others will dispel Lewis’ claims.

Options Growth Open

Yet, this is a key period for BATS, which closed its merger with Direct Edge earlier this year, and provided BATS a massive boost in terms of combined order flow in its cash equities business. It now holds about 20 percent of the US cash equities marketshare in terms of volume, and is the top cash equities platform in Europe.

That combined growth of the company stands to benefit BATS’ Options business as well. BATS Options now has a full-time sales team to help promote its products. Also, Citadel and Goldman Sachs, which were stakeholders in Direct Edge, are now stakeholders in the new exchange. Such relationships do not guarantee more options order flow, Johnson said, but it does open a door that was previously not available. Direct Edge also boasts the largest share of the retail equity market, a demographic that may also help bolster options volumes for BATS Options.

BATS hit its highest marketshare level of 4.5 percent recently and is now looking to leverage its equity volumes, sale force and new relationships. He said a longer term marketshare goal of 9 percent to 10 percent is not unreasonable.

“We have a lot of macro drivers for growth,” he said. “I don’t know a single retail firm that is not investing in complex trading functionality and complex order education. And we continue to get institutional users into the marketplace. It’s never been a flood of institutional users, but there’s been a steady trickle.”

He added that weekly options have been a hit industry-wide, and that too may help bring more participants and volume into the options industry.


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