While the big news today is that BATS Global Markets is in exclusive talks to acquire Chi-X Europe, BATS’s subsidiary BATS Options Exchange recently filed a proposal with the Securities Exchange Commission to apply a new “directed order” model at that exchange. A Wall Street Journal article said: “The proposal would not see all options prices on BATS’s market quoted in half-cent increments. Rather, traders offering to improve prices for incoming options orders would be able to offer a “midpoint price,” which could come in at half a cent depending on the size of the spread between the bid and ask for a specific contract. BATS also has asked regulators to allow its market makers to designate preferred customers, who would be offered special prices on their options orders.”
BATS Options, launched in February, still gets a small percentage (1.3 percent) of the U.S. options business, but is working hard to change that; in addition to this proposal, the exchange earlier this month instituted a new rebate structure. Jeromee Johnson, vice president of market development at BATS, talked with Sarah Rudolph about the proposal and what it means for market makers and customers.
Q: I wanted to follow up with you about BATS’s new proposal to trade some options in half penny increments. You were quoted in the Wall Street Journal as saying it would “promote competition among market makers and give customers better prices on their trades”? How would it do that?
A: First, I think that something that was not totally clear in the article is what is NOT in the proposal. We are not asking to price options at every half-tick. So, if your market is $1.11 by $1.15, I’m NOT proposing 11, 11 ½, 12, 12 ½…14 ½ and 15.
Most of the calls I’ve been getting [about this proposal] seem to suffer from this misconception. If you read the [SEC] filing you will see that the vast majority of the proposal centers around functionality that relates to market maker preferencing and directed orders. The proposal would give customers the ability to direct their orders to the market makers of their choosing within our price/time market, and it would allow market makers to control who is allowed to preference them and the structure under which that would take place.
As part of that proposal, we are requesting that the SEC allow those market makers to be able to price improve those customers that are directing orders to them to a midpoint price [halfway between the bid and the offer – the midpoint of the NBBO].
What is correct is that when you have an odd spread, the midpoint is a half penny. If the market is 11 by 15, the midpoint is 13. If the market is 10 by 15, the midpoint is 12 ½.
There was a proposal put forth some months ago by the cash markets that quoting be allowed in half ticks for a subset of names. That’s fundamentally different from what we’re suggesting on the options side.
Quoting and trading at those half ticks not currently allowed on the cash markets. It was proposed as a pilot to address the large volume of transactions in some of those names mostly executed in dark pools. Those concerns are not same as those in the options market. It would be a solution to a problem we don’t have.
Q: What problem does your proposal address?
A: The program is designed to facilitate some of the counterparty to counterparty interactions that happen on the classic options exchanges today. It would bring the interaction that exists on the CBOE, Amex, Phlx and other exchanges to a price-time marketplace. We are today a price-time marketplace. Classic retail firms want to direct orders to market makers they have a relationship with; they can’t do that on the BATS options exchange. The program we’re proposing is a way to allow that to happen.
What I’m proposing is not a separate auction or separate exposure period. Just that the market maker be allowed to get a price improvement for those directed orders, and as long as they’re on the NBBO to begin with, they must be there contributing to price and size discovery in the market place. If the market maker is doing that, I’m suggesting allowing them to price improve better than the NBBO for orders that are directed to them.
Q: You were quoted as saying you expect the competing markets to protest. What objections to you expect they will have?
A: We’ll see what the comments to the SEC ultimately bear out. We’re talking about a program substantially different from what’s out there today. Currently we don’t even have penny pricing – we have a penny pilot – and this takes it one step further. So I can see people being concerned. The U.S. options markets are highly competitive, and exchanges often comment on proposals by other exchanges.
Q: So the SEC is receiving comments on the proposal now?
A: Yes, we’re in the comment period right now. That period ends Dec. 28.
Q: Someone on the Options Insider forum posed the question: “What’s in it for market makers? How can they work with those kinds of margins?” Does this proposal create any difficulties for market makers?
A: I think that is a misunderstanding. The proposal is designed for market makers. It is designed to allow market makers to interact with the flow that they want in a different way. They can receive direct orders today on any of the classic exchanges. I’m proposing to allow them to do that here in return for being on the NBBO. So they have the potential to capture a greater percentage of the client orders they want.
Q: With “preferred customers” and “special prices”, does this model provide equal access for all participants?
A: Under the proposal we remain a price-time market place. Directed orders and preferencing already exist in the marketplace. There are those relationships between order-sending firms and market makers. We’re trying to both allow those and allow competition for the orders that take place in those programs, under a different structure. Even after this proposal is in place, if it is approved, we will continue to be a price-time marketplace.
Q: A little earlier this month Bloomberg reported on BATS’s new rebate structure, in which you rebate traders 50 cents a contract to create the best prices on BATS, which the article said was designed to attract the fastest traders to your platform. That is something different and apart from this new proposal, isn’t it?
A: Yes. We announced pricing changes for January. There is nothing about speed in our pricing changes. We are raising the rebate and lowering our take charges on the firm and market maker side. We are moving up the rebate structure substantially – almost doubling the rebates on the offer. And a novel part of the pricing, something new for the industry, is that for anyone setting the NBBO, for anyone creating a new price level in the market, we’re offering a rebate size of 50 cents. Dangling a big juicy carrot for you come January to put that price up on BATS first.