Observations & Insight

Swimming With the Sharks in Miami Beach: Shelly Brown of MIAX Talks Competition
Sarah Rudolph, JLN

As the the newest independent options exchange, having launched on December 7, 2012, MIAX has had impressive growth considering the odds of competing against 11 other established exchanges.

We spoke with MIAX’s CEO Shelly Brown at the Options Industry Conference in Miami Beach earlier this month about what MIAX is doing to stay competitive and about the challenges the industry is facing as a whole.

The exchange’s market model is what sets it apart, Brown said. MIAX is a pro-rata allocation, conventional fee exchange with payment for order flow, closest to the CBOE, PHLX, AMEX, and ISE model (before ISE went maker-taker in penny names) – and it competes mostly with those four exchanges and less so with the price-time maker-taker exchanges.

The exchange also caters to liquidity providers. MIAX’s structure is built around the two equity rights programs it has launched, giving its partner firms equity in the exchange in return for providing guaranteed liquidity. The original partners were Wolverine, Susquehanna International Group, Morgan Stanley, Knight Capital Americas, Interactive Brokers Group, and Bank of America-Merrill Lynch. Merrill-Lynch did not stay on for the second program, but two new firms joined – Citadel and Optiver – and the other five re-upped.

“The view we have is that the majority of customer retail flow in options is routed by a small group of consolidators, who are also liquidity providers,” Brown said. “We built a market structure we thought would work well for them and be equitable for all involved. We don’t cater so much to the high frequency traders but rather to a market maker community that is required to make markets in all the options in all classes. They have risk across 60,000 different products at any given time.”

These firms are motivated by several different things – fees, safety protections, and being able to quote quickly and get out of the way quickly, he said, and the MIAX model was built around their needs. That creates an environment for consolidators where they can trade against their own order flow and offer price improvement opportunities to their customers, but they can also interact with the other firms, Brown said.

“[The model] has played out very well for us – we’ve gone up to the low 7 percent market share recently, at times 7.5 percent. And that is only in equity options – we don’t trade index options,” he said.

MIAX joined the price improvement marketplace in August of 2014 when it rolled out MIAX Prime, its price improvement auction. Brown said that on any given day that the auction provides 30-40 percent of the exchange’s volume.

One thing the exchange is planning in order to grow its market share further is introduce complex order functionality, expected later this year or early next year. Complex orders make up as much as 30 percent of volume in retail options on any given day, Brown said.

One area in which MIAX will never compete is in floor-based trading, he added. About 15-25 percent of options volume is still done on the floor, but MIAX is all-electronic.

“If you look at the fact that we don’t yet have complex functionality and we don’t compete with a trading floor, that’s 40 percent of the market we can’t touch. So our 7.5 percent share works out to a pretty large market share,” he said.

The OCC’s new capital plan has divided the options exchanges, with the OCC equity-owner exchanges on one side and the non-owners, all newer exchanges, on the other. MIAX has joined a petition to have the SEC take another look at the capital plan.

Brown said his view is that the plan is unfair to the members.

“The new plan gives a very large rate of return to a limited number of exchanges and could create a scenario where those exchanges have competitive pricing advantages over the other exchanges. The bigger concern to us is the members, the market making and retail community, everyone paying OCC fees, that money is now being used potentially as a way for the owners to monetize their stake in OCC,” he said. “We don’t believe that was the original intent of the OCC.”

He added that if the OCC is run in an equitable fashion, MIAX doesn’t need to have ownership in it.

“We’d be more than happy to leave the OCC the way it is, with just the five owners, but they should not receive excess financial benefits as a result of this capital plan,” he said.

MIAX has a number of challenges facing it, as does the options industry as a whole. One concern is the number of retail customer orders that go into price improvement auctions. Brown said the auctions are great for retail clients in the short term, because they are getting better prices, but the unintended consequence is it reduces the probability of a market maker trading on the displayed bid-ask spread with a retail customer. Therefore, market makers are trading most of their volume against professionals, where there is a greater probability of loss and of negative expectancy to those trades, Brown said. This leads to two of the problems that were much discussed at the Options Industry Conference: lower liquidity and wider spreads.

“The options market is a quote-driven market, unlike the equity markets. If we want liquidity providers to provide liquidity in options, they have to have an incentive,” he said. “The market makers are out there to be profitable. Profit is not a bad thing. Excess profit isn’t right but if you want people to take risks, they have to be able to make money.”

Lead Stories

Markets Are Jumpy Over Coming Leap Second
By Stephanie Yang, Dow Jones Business News
Wall Street’s latest worry: Y2K’s distant cousin, the leap second.
Traders and exchange officials are prepping for the latest incidence when a seemingly innocuous time change could potentially cause havoc if computer systems aren’t made ready.
In this case, it is the leap second, an event that happens every few years when the standard time around the world is adjusted by one second to account for a slight mismatch between clocks and the Earth’s rotation. With lightning-quick trading tied to computers now the norm in markets, the leap second has regulators, exchanges and traders worrying about potential pitfalls like it is 1999.

Investors Turn To Gold ETF Options As Hedges
By Saumya Vaishampayan, WSJ.com
Investors seeking to protect their portfolios against recent swings in currencies and government bonds are snapping up options on a gold exchange-traded fund.
The activity started back during the rout in government bonds, which sent German 10-year yields surging from record lows, and has continued as currencies continue to swing.
Options on the SPDR Gold Trust GLD -1.49%, traded under the ticker “GLD,” were among the most heavily traded Tuesday, with bullish call options dominating activity. The euro is down 1.6% against the dollar Tuesday to $1.113.

Hedge Funds Trim Bullish Nasdaq Bets as Cost of Protection Soars
by Sofia Horta E Costa, Bloomberg
Enthusiasm is waning among the largest speculators for the rally that has sent the Nasdaq 100 Index up more than 25 percent in the last 16 months.
Hedge funds lowered their net-long positions on the gauge of technology shares at the fastest pace since January last week, cutting them 31 percent to 46,265 futures, according to data from the Commodity Futures Trading Commission. That’s about half as many as they owned in April. At the same time, options protecting against declines in the equities surged to their highest price ever relative to bullish contracts.

PUT Index Hits All-time Daily Closing High, with Less Volatility
Matt Moran via LinkedIn
On May 18 the CBOE S&P 500 PutWrite Index (PUT) closed at 1507.95, its highest all-time daily closing value. Since mid-1986 the PUT Index has had higher returns and lower volatility than the S&P 500 Index, the 30-Year Treasury Bond Index (Citi), and the S&P GSCI Index. In most years since 1990, the markets for S&P 500 (SPX) options generally usually have been richly priced.

Oil volatility fades as risks become more balanced: Kemp
LONDON | By John Kemp, Reuters
Oil prices have become much less volatile in recent weeks as the record short position previously established by hedge funds has been squared up and prices return to a level at which many U.S. shale wells are profitable.
Realized volatility, a technical measure of the day to day variability in prices, has fallen to an annualized rate of just 24 percent, down by more than half from its peak of 60 percent in late February.
Volatility in front-month Brent futures has dropped to its lowest level for almost five months and is now roughly in line with the very long-run average of about 27 percent.

A Monetary Policy At Warp Speed – A PIMCO Viewpoint
Some central banks are now purposely creating negative interest rates in an effort to nudge investors outward along the risk spectrum. This policy could lead to some unexpected consequences.
Due to investors’ general tendency toward risk aversion, both implied and realized volatility around the zero line may be higher than what risk models expect.
Another unconsidered consequence of negative rates concerns the risk management of financial derivatives. Most option pricing models cannot readily accommodate the negative rate dynamic.
An imaginative twist on theoretical physics forms the premise of the science fiction series “Star Trek”: An engine called a warp drive enabled the Starship Enterprise to travel faster than the speed of light, going beyond known space to uncharted, exciting new worlds. The confounding detail was managing the sheer power inherent in the warp drive, including its potential to behave in unexpected ways.


Deutsche Börse to set up Europe’s first multi-asset RMB platform
German exchange group signs joint venture deal with CFFEX and Shanghai Stock Exchange to bring trading venue to Frankfurt Frankfurt has strengthened its position as a major RMB trading hub with a joint venture deal between Deutsche Börse and its Chinese counterparts

HKEx to decide in coming weeks on plan to curb closing volatility
The Hong Kong stock exchange said it expects to make a long-awaited announcement in coming weeks on a controversial proposal to rein in volatility which large investors favour but small investors say discriminates against them. Under the proposal, unveiled in January, Hong Kong Exchanges & Clearing (HKEx) plans to introduce a so-called closing auction and other volatility curbs that would bring it in line with international peers in New York and Europe.

NSE to introduce new facility to prevent self trade
PTI, New Delhi
To check self-trades, National Stock Exchange (NSE) today said it plans to introduce new facility in the equity, currency derivatives and Futures and Options segments.
The new facility will prevent matching between a buy and a sell order entered in the same order book by a member for the same client code originating from same or different trading terminals of the member.
In case an active order is likely to match with a passive order belonging to the same member and client code combination in the same order book, then such an order would be cancelled by the exchange, NSE said.

New limit for derivatives trading may benefit investors
Move Sebi’s indirect way of telling investors they need to be careful while trading in this segment
Ashley Coutinho, Business Standard, Mumbai
The Securities and Exchange Board of India (Sebi) reportedly plans to raise the minimum contract size for trading in equity derivatives. The lot size will be raised from the existing Rs 2 lakh to Rs 5 lakh or Rs 10 lakh.
This is the first time since derivatives trading kicked off in India that the market regulator plans to raise the limit for the minimum contract size.

New hedging tools needed for Shanghai-Hong Kong stock link
Ray Chan, South China Morning Post
Cross-border trading scheme’s lack of options to smooth volatility is discouraging institutional money managers from greater involvement
The launch of means to hedge against downside risk is the next step in encouraging investment through the stock link. Photo: Reuters
The launch of means to hedge against downside risk is the next step in encouraging investment through the stock link. Photo: Reuters
A lack of hedging options to smooth volatility for investors buying mainland shares is holding back institutional money managers from fully exploiting the Shanghai-Hong Kong Stock Connect trading scheme, industry insiders say.


Better Ways to VIX ETFs
Max Chen, ETF Trends
Traders are gaining more efficient avenues for hedging volatility without the costs associated with futures contracts through two new AccuShares Spot VIX exchange traded funds.
On Tuesday, AccuShares Investment Management brings to market the AccuShares Spot CBOE VIX Up Shares (NasdaqGM: VXUP) and AccuShares Spot CBOE VIX Down Shares (NasdaqGM: VXDN). VXUP will try to reflect the spot price return of the CBOE Volatility Index, or VIX, while VXDN will try to mirror the inverse of the VIX.

Jim Strugger’s Options Strategy For Marvell Technology Pre-Earnings
Ritesh Anan, Benzinga Staff Writer
Marvell Technology Group Ltd. is set to announce its first-quarter results on Thursday and there isn’t much that the Street is expecting from the company after its negative guidance.
MKM Holdings Derivatives Strategist Jim Strugger was on Bloomberg Monday to discuss his options strategy on Marvell going into its earnings.
Reasoning Behind The Trade
“So there is a bifurcation in the Chinese smartphone market,” Strugger said. “Mass market demand [is] weak, but there is an ongoing and strong migration to higher-end smartphones. That has created divergences among the component suppliers. So, among the losers, at least in the short-term, are Marvell…The winners include Skyworks, SWKS, and Avago, AVGO.”

What the DOW is Going On?
By Joe Cusick, CBOE Options hub
How many times did you hear last week that the Dow Industrial’s hit a 3-month high or that the S&P 500 set a new record close? Sounds like the sky is the limit, but is it?
I often discuss how lagging markets or sectors tend to be the bane of market strategists with a directional opinion. Recently, I discussed how the Dow 30 has been anchored by two of its sister DOW indices: Utilities and Transports. If you look at the chart below (see chart 1) of the Diamonds (ticker: DIA) which tracks the 30 stocks in the Dow Jones Index, you can see that it closed at a 3-month high and is just off its March highs.

Alibaba: A Bet On China’s Emerging Middle Class
Despite stock’s recent slide, online retail giant has as many mobile customers as U.S. has By Steven M. Sears, Barron’s
Investors should look past Alibaba’s growing pains – the latest being a federal counterfeiting lawsuit filed by a French luxury retail giant – and focus on what the company represents: a trade on China’s expanding middle class.
The expansion of China’s middle class is one of the world’s most intriguing investment opportunities, and few stocks are better situated to profit than Alibaba Group Holdings (ticker: BABA ), China’s largest e-commerce company.
Once Alibaba irons out operational wrinkles – and I believe it will – the company could be seen as a powerful cross between Amazon ( AMZN ) and eBay’s ( EBAY ) PayPal that enjoys significant first-mover advantage in the world’s most important emerging market.

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