Jeromee Johnson is vice president of market development at BATS Exchange and a leader in developing the BATS Options Exchange. He talked with Sarah Rudolph about BATS Options, the newest of the eight U.S. options exchanges currently operating.
Q: Can you give us an update on what’s going on at BATS?
A: We just completed the last of our rollout in mid-May following the last wave of options symbology consolidation. We added the last of our formally planned listings, bringing us to offering listed options on close to 2200 underlyings. Following that, in the beginning of June we lifted our market maker trading restriction – took the training wheels off, so to speak. Through the rollout we were open for trading only on series in which we had registered market makers. As we moved through the rollout, we were active in 4,000 series, then 8,000 then 10, 12, 15,000 series in a given day. Since we lifted that market maker restriction, we are active and open in all the series in all our listed underlyings: 240,000 series open for trading every single day.
We’re still by far the smallest options exchange, with about 1 percent market share – 100 basis points give or take. That’s roughly half or 1/3 the share of the other small exchanges, such as BOX or NOM. They run 2-3% most days. We have had a nice steady volume growth. We’re feeling good about where we are after completing the rollout.
Q: According to a Wall Street Journal article on BATS’s launch, BATS saw penny pricing of options and high frequency trading as an opportunity to succeed with a new exchange. How has that played out?
A: We see continued expansion of the penny names, continued growth in volume, more institutional and algorithmic trading in the marketplace — more of the high frequency traders, folks who trade options in an order driven manner where the rebate associated with maker-taker scheme calculates into the way they approach options trading. The Philadelphia Stock Exchange has had phenomenal success with maker taker pricing, for example. And the International Securities Exchange (ISE) originally was against maker-taker pricing but today are offering maker-taker pricing in some of their options.
Whether in high frequency trading or slower trading, the incentives with the maker taker model are the correct incentives, broadly, for the marketplace. You pay those who are committing capital and taking risk. Those who are accessing and using publicly displayed prices and removing liquidity, you charge them. That makes sense to me. PHLX in particular has had phenomenal success combining maker-taker with their pro-rata allocation model. We run a price time allocation.
Q: Before you joined BATS, you were president and head of operations at 3D Markets, where you helped develop the first block options crossing network. What inspired the move and how did it pan out?
A: The move was coincident with our sale of the firm to Pipeline Financial Group where they’re still having a lot of success in targeting the institutional market. Talking about what worked at 3D and what’s working here at BATS, both firms’ businesses were built on many of the same macro trends we’ve just been talking about. They are different sides of the same coin. What we were doing at 3D was big, chunky, dark, trading occasionally. Our average order size was between 12,000 and 15,000 contracts. The average execution size on the exchanges is under 20 contracts. 3D was about masking the members – protecting their information. As an exchange, you must provide fair and equal access. It’s the opposite of a crossing network. But trends like fragmentation of liquidity, growth of institutional trading, pennies, automated liquidity providers – all those trends are very much the same. They were apparent to us more than two years ago when we started 3D. They are the same trends that BATS is positioned for today.
Q: What’s in the future for potential options dark pools?
A: A dark pool in options is fundamentally different from an equities dark pool, because you have no internalization or trade reporting facility that determines the way trades are executed away form the exchanges. The trades being matched in our pool of liquidity were ultimately executed on an exchange. We’ve seen other options dark pools come on line with different levels of success – Ballista is gaining traction, a few other firms are looking at different models to match, cross, pair off or otherwise find liquidity. Flex options or longer dated options are popular as well. Or trying to replicate the internalization-type trades happening in equity dark pools. So, there is a substantial amount of interest and I expect continued competition on that front as well.
The growth of the options industry to some extent will be driven by the institutional side of the marketplace. What tools do those institutions need for their large-size orders? What in the equities world helps them navigate a fragmented, quickly moving landscape? DMA platforms, algorithms, etc. In the options market, those tools are nascent, immature. So there is potential and demand there from institutional clientele.
Q: Does the recent talk of the dangers of algorithmic trading (including its possible role in the May 6 market debacle) have any merit? Should it be more closely regulated?
A: No — algorithms are no more dangerous than someone walking into a crowd and trading beyond their limits was two decades ago. There is danger and risk in trading. You look at the complexity of our marketplace; whether algorithmic or high frequency trading, we have a highly fragmented, intricately interlinked marketplace, where liquidity is super mobile. That said, certainly concerns have been raised in the last six months — not just around the events of May 6th. There has been a review of non-displayed liquidity. The SEC and CFTC have started working together to get markets more aligned with each other, and products are crossing over more and more. It is a regulatory and governance task that shouldn’t be taken lightly. But algorithmic trading has no more risk than picking up phone and getting flipped to someone working on the OTC desk whom I don’t know and structuring a product I don’t fully understand.
For all the reviews and work we and the regulators are doing, the listed markets functioned very well going back to the market disruption a couple of years ago. While things literally stopped trading in the OTC markets, the listed markets – options and equities – remained highly competitive, transparent and liquid. The market sold off hugely but there was not the same disruption where people picked up and left.
A: The equities exchanges did a good job of putting some changes in place quickly to the existing circuit breaker framework. We had to work within the circuit breaker framework we already had. We couldn’t change it completely in the time frame we were working in. All the exchanges were in favor of working with the SEC to get that in place. We don’t believe that is the best long term solution, however and are suggesting that the securities markets move towards a more futures-like limit down, limit up type solution.
Q: What about the proposed caps on option fees?
A: We’re in favor of the fee caps. That was a regulatory hole that needed to be plugged. What the commission has proposed is to move everyone else to our price point. We’re already within the cap as proposed. But if everyone else’s prices look like ours there’s probably some follow-on effect. Is 30 cents the right number? Putting the cap at the same level as the cap in equities is a place to start the discussion as any. Putting my investor hat on, whether retail or institutional, having one price maximum whatever and wherever I’m trading makes a lot of sense to me.
Q: What’s next for BATS Options?
A: Later in June or in early July we’ll be releasing a set of post-trade tools for our members to allocate their trades across accounts, do their own CMTA [Clearing Member Trade Assignment] changes, without having to call our trade desk. We also have a suite of risk management tools to provide additional protections for liquidity providers and market makers. We’re looking at how we can control their risk exposure in a different environment.