At the Options Industry Conference this year, the exchange leaders panel directly followed a presentation by Andy Nybo, head of derivatives at The Tabb Group, that offered a rather bleak look at the options industry. Total volume year-to-date was down 8.7 percent compared to a year earlier, bid-ask spreads have been getting wider, and options exchanges are finding it difficult to compete in a field of 12-going on-14 players.
Given that “dark cloud” the industry appears to be under, moderator John Lothian asked the panel what the industry could do to turn it around.
Exchange leaders agreed that the lack of liquidity was a big problem and that, as the ISE’s Boris Ilyevsky said, a major cause was that the current market structure does not incentivize active, liquid quoting.
Steve Crutchfield of NYSE said banking entities are finding it harder to be in the options business right now, because of the Volcker rule as well as the higher cost of capital.
Concerns about risk have increased, as have opportunities to put that capital to use in other ways, he added.
The panel agreed that the increased use of auctions is also to blame for some of the industry’s woes. As a possible solution, Ilyevsky suggested the industry could require auctions to start at a penny better. This could be rolled out as an experiment, starting with only a handful of names, he said.
But market makers need an incentive to quote better, BOX’s Ed Boyle said. “Market makers can’t afford to put a quote on 12 exchanges continually and have us expect them to have narrower spreads.”
Lothian asked whether so much complexity had been added to the options market that it was beginning to resemble the equities market, to its detriment.
While the options market is complex, the CBOE’s Ed Provost said, it is “so much better than the equities markets, where so much is traded in the dark.” The fact that options are traded on exchanges gives that market a great advantage over equities, he added.
BATS’ Jeromee Johnson countered that the OTC options market is the equivalent of a dark market, and that “the equities market is one of the best, tightest, most efficient markets out there. It’s okay that the options market is like the equities market in certain ways.”
Recent regulations have also harmed the market, taking away some of the industry’s ability to innovate, according to MIAX’s Shelly Brown.
Provost said that Reg SCI, like many regulations, started out with good intentions but “unfortunately, hiccups in the industry led credence to the idea that those rules would make sense.”
The idea of combining the two regulatory agencies, the SEC and the CFTC, has been brought forward many times but has never come to anything. Although some of the panelists said it would greatly simplify regulations, Provost said it was very unlikely ever to happen, “so we have to deal with things as they are.”
One topic that garnered a bit of debate was the OCC’s controversial new capital plan. As a newly-designated systemically important financial market utility (SIFMU), OCC was required to significantly raise its capital buffer, and some are concerned that the new rules favor certain options exchanges over others. The exchanges that are not equity owners in OCC feel that it favors the equity owners and inhibits exchange competition, and have filed a petition asking the SEC to take a second look at the plan.
Jeromee Johnson, whose exchange is not one of the equity owners, said, “It’s tricky when you take a potential monopoly and try to monetize it.”
Ed Boyle agreed. “The OCC has to operate without putting an undue burden on participants, and the capital plan puts undue burden on competition,” he said.
Provost, whose exchange is one of the original owners – in fact, the original owner – of the OCC said that in the short term the plan serves its purpose, and that although many are unhappy with it now, it may at some point “evolve into something satisfactory to everyone.”
As Crutchfield pointed out, all the options exchanges feel that having a properly capitalized OCC is crucial to the industry.