Plan for New Trading Pit Triggers Feud in U.S. Options Market

By Gunjan Banerji Features Dow Jones Newswires

Traders on Wall Street have lamented the end of floor trading. Now, one exchange is trying to launch the first new open-outcry pit in the U.S. in decades.

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But rivals and trading firms aren't rejoicing.

Box Options Exchange LLC hopes to open a new floor for about 40 human traders at the Chicago Board of Trade Building. The exchange, which has one of the smallest market shares in U.S. options, is trying to grow its business by vying for orders executed via open outcry, which has persisted in options trading.

Its initial plan sparked critical letters this year from rivals CBOE Holdings Inc. and the New York Stock Exchange, owned by Intercontinental Exchange, as well as trading firms, who said another trading venue will exacerbate the market's fragmentation or lead to less transparency.

Though Box overhauled its proposal to address concerns, Nasdaq filed another letter last week, saying the new floor needs to be populated with market makers, trading firms that stand ready to both buy and sell against existing orders.

"Having an empty room would be completely contrary to the spirit of the trading floor," said Kevin Kennedy, head of U.S. options at Nasdaq, in an interview. "My main concern is liquidity. I want to see an ample pool of liquidity on the trading floor," he said, referring to the ability to get trades done.

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The U.S. Securities and Exchange Commission plans to make a decision on the new floor by Aug. 2, documents show.

While trading floors have dwindled in almost all markets because of a shift to electronic trading, old-fashioned shouting and hand signals in open-outcry pits have endured in the options market, where investors sometimes prefer human traders to execute complex orders rather than computer programs.

Open outcry accounts for about 13% of U.S. options trading, according to Burton-Taylor Consulting, which advises exchanges. Most trades are done electronically. Over 350 million options contracts exchanged hands in June in the U.S., with about 2% flowing through Box, data from Options Clearing Corporation show. Box is partly owned by TMX Group, which operates the Toronto Stock Exchange.

Backers of the company's proposal say it will boost competition among exchanges. Some also say it's Box's right to try to build market share in the fiercely competitive options landscape, where a select group of exchanges like the NYSE, Nasdaq and Chicago Board Options Exchange run the existing floors.

But Box's efforts have rankled some U.S. options traders, who are already dealing with a labyrinthine market structure. A new open outcry pit would push market makers to staff the new floor and incur higher costs, said Peter Maragos, chief executive of Dash Financial Technologies, a broker dealer and technology provider.

"Where's the benefit for the client?" said Mr. Maragos, whose firm has brokers on the CBOE floor. "We're just adding more complexity, more fragmentation."

The SEC doesn't restrict the number of exchanges, said Box Chief Executive Ed Boyle. It only creates the legal and regulatory requirements that exchanges must follow. He also pointed to the existing 15 venues for U.S. options.

"For someone to make the statement 'Why do we need another one?' is naive," said Mr. Boyle, who has worked in options since 1981. "It really comes off as they don't want additional market competition."

Steve Crutchfield, the head of market structure for CTC Trading, opposed the new floor in a letter to the SEC. He said that a sparsely populated floor can make it easier for trading firms that handle client orders to seek venues where they get paid commissions, rather than where they can get the best prices for clients. His firm staffs all four existing open-outcry floors.

One of the changes Mr. Boyle made in response to criticism was to nix a requirement for traders to post continuous electronic quotes if they have a floor presence, which others don't require.

Some options traders said the open-outcry model could help investors who want to prevent prices from moving when their large options orders are getting executed.

"There is still a role for human traders," said Andy Nybo, a director at Burton-Taylor Consulting.

An NYSE spokeswoman said 25% to 40% of the exchange's options volume flows through two floors in San Francisco and New York. The number of CBOE floor traders has fallen, but over half of its most lucrative products -- including options on the S&P 500 index and CBOE Volatility Index -- are carried out on its Chicago floor. Nasdaq still operates an open-outcry pit in Philadelphia. And while CME Group closed most of its futures trading floors, it maintains pits for S&P 500 futures and options on futures, where everything from corn to hog options is traded.

Box isn't the first exchange to consider a new floor in recent years. Before being acquired by Nasdaq, the International Securities Exchange had considered an open outcry floor but eventually decided against it, said a person familiar with the matter.

But its plan has stoked worries that, if approved by the SEC, the new floor could lead to other exchanges trying to launch their own.

"Approving the proposal would open the floodgates for every options [exchange] to open empty 'trading floors' in disused office space," Mr. Crutchfield wrote.

(END) Dow Jones Newswires

July 09, 2017 09:14 ET (13:14 GMT)