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 Shelly Brown, senior vice president, strategic planning and operations at MIAX, at the Options Industry Conference in Miami Beach earlier this month about what the exchange 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.
Once 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.”