BOX CEO Tony McCormick A Year Later
JLN Options Newsletter last spoke with Tony McCormick, CEO of the Boston Options Exchange (BOX), in November 2009. He discussed some of the changes the exchange was making, including abandoning the maker-taker model in favor of a price-time model that rewards the liquidity taker. Now, a year later, he spoke with Sarah Rudolph about the results of those changes and what will be happening with BOX and the options industry in 2011.
Q: We last spoke about a year ago, although more recently JLN Options talked with John Goode, BOX’s CIO, about some of the technological improvements BOX has made in the past year. Can you briefly sum up the past year’s developments at the exchange?
A: A year ago we were definitely an exchange in transition. We needed to change our business model and realign our strategy in the marketplace. I think we spent significant time thinking through that and figuring out how to add value in a market that is well served by a number of participants. I think the market understood what we were trying to accomplish; we saw significant results about mid-year.
Yesterday [Monday, January 3rd] was busy for everyone, but on a percentage basis our market share hit a high at least since I’ve been here: it approached 4 percent. A year ago we were half that. So I am very encouraged. We’ll continue to gain share this year because I really believe what we’ve been doing is unique. Initially they said what we were doing [with the Price Improvement Process (PIP)] was wrong, improving customer order flow was wrong, and now they’re copying us.
We were the first to introduce idea of price improvement. We are ideally suited for retail order flow. As execution quality becomes more transparent to the retail trader, more flow will come our way.
Q: What does BOX have in the works for the coming year?
A: We will continue to modify our technology. We have a great platform – our SOLA software is excellent — and we moved our data center to Equinix, which was a great contributor to our success.
Q: Is that mostly because of the co-location?
A: It was because of co-location and also because they are a great solutions provider, very reliable. Everything they said they’d do they delivered, which is always a pleasant surprise.
Some other things we’re working on: We’re still in the process of trying to get our SRO launched. We made progress but we’re not there yet. You have to satisfy the SEC that everything you’re proposing passes muster in oversight, independence of the SRO from the operating business. We also have a concentrated ownership issue that has to be addressed.
We are also focusing on realignment of our shareholders to create additional value – we want to bring in participants that can commit order flow. We have a business proposal we are vetting with them and we’re in the process of those discussions. The headwinds that slowed down that process last year: some participants were potentially interested in the Amex deal, which still has not received approval by the SEC, so there was some reluctance to participate in a new arrangement when they were already in one that had been approved. We’re still waiting for [the Amex deal] to pass the SEC’s approval process. I have heard it’s imminent.
Also I feel that without having the SRO further along — even filed in a comment period — certain participants were saying, “We’d like to see that take effect first.” It’s a vital link between an exchange and its regulatory authority. We’re working diligently on that.
Q: When I spoke with John Goode he mentioned one of the exchange’s technology projects was “refining” the PIP. What goes into that process?
A: We recently filed with the SEC for cede quantity modification to the PIP. An initiator on the liquidity side of the PIP at the NBBO could voluntarily cede their part of the trade to a competitive liquidity provider – up to 100 percent of the trade [where the limit was originally 40 percent]. So if that liquidity side doesn’t care if they make money, they just want to be on the trade, they could participate at the NBBO.
Q: You have been focusing on retail customers. What is the ratio of retail to institutional customers on BOX right now, and do you expect that to change in 2011?
A: We have a very high percentage of retail trading, about 85%. That’s our sweet spot. I still think retail is about 1/3 of the industry. The interesting part where we could see significant growth is the advisor world that exists in equity portfolio management for retail customers. Those advisors are getting much more interested in the options space for their customers. It has been growing for the last couple of years. I think they’ll be doing more with their customers to use equity options. A lot of the new younger managers are much more conversant with options than their predecessors were, which is a plus.
Q: You mentioned when we spoke a year ago that internalization is an important issue in the options industry. Have you seen the ‘envelope of internalization get pushed’ as you suggested would happen?
A: I think the latest version of that is BATS’ proposal for directed orders. In their proposed set up, liquidity could be internalized 100% if they are in a non-penny name and there’s a hidden penny there. I think they will get a reaction from the ISE, because ISE got crucified for their own internal cross proposal.
Orders must be flashed to more than one participant; otherwise you get in a TRF environment where everything just goes to the tape. That would be a huge migration from where we are now in the options world. There are very strict rules about trading in options. If you want to facilitate a trade, there is an exposure period so others can potentially improve the trade. This is controversial because of the flash exposure for step up. BATS is pushing the envelope further – proposing that orders be sent directly to the liquidity source without being exposed – in other words, internalized 100%, using a hidden penny to improve the bid offer by a penny inside the nickel. That’s a cross – they are just crossing an order by the nickel market. There will be lot of comment but I doubt it will pass muster with the SEC.
Q: What is the biggest change in the industry you’ve seen since this time last year?
A: It’s not so much a change, but I guess I was a bit surprised by how much interest there was in the weekly options. I had questioned whether that was a bona fide idea that brings value. I guess I was wrong about that, because there is a lot more trading in weeklys than I expected.
I’m not sure I embrace the dailies they are proposing. The problem I have is you get to a point where you are just trading the underlying on a daily basis and adding leverage to it. It’s too casino-like.
Q: Will BOX be affected at all by the Dodd-Frank rule implementation?
A: Not so much, because we’re not in the swaps arena and that’s where the rules will initially take effect. I think there is room for more over-the-counter flex-type products in options to come onto listed exchanges, however. We’re looking to develop something there. Those markets are wider than they should be, so the layoff comes to the listed side but the actual transaction takes place OTC.