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

By Gunjan Banerji Features Dow Jones Newswires

Many Wall Street traders have lamented the steady demise of floor trading. But now that one exchange is trying to launch the first U.S. open-outcry trading pit in decades, it isn't exactly being welcomed.

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

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

It would be a needed respite for floor traders, many of whom have sought new jobs since screen-based trading took off in the 1990s. Intercontinental Exchange Inc., which owns the New York Stock Exchange, ended floor trading for options on futures in 2012, and CME Group closed most of its futures trading pits in 2015. The largest options exchange, Chicago Board Options Exchange, has seen its floors thin to about 440 people earlier this year from 10 times that in the late 1980s.

Box's initial plan, though, sparked critical letters this year from Chicago Board Options Exchange owner, CBOE Holdings Inc., and the NYSE, as well as trading firms that said another trading venue will make it tougher to do business as activity potentially becomes less transparent and more fragmented.

Nasdaq Inc., which also operates options exchanges, has filed three comment letters about its concerns. A main one is that a Box trading floor, if approved, could sit empty for a few months, potentially leading to worse prices for customers if not enough market makers are competing. Since trading firms take time to get new people trained and registered, Nasdaq argues that Box shouldn't be allowed to open until the traders, known as "market makers," are ready to participate.

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"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.

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

Open outcry accounts for about 13% of U.S. options trading, according to Burton-Taylor International 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 is 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 scrap 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. 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. While CME Group closed most of its futures trading floors, it maintains pits for S&P 500 futures and options on futures for everything from the S&P index to hogs and corn.

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.

Write to Gunjan Banerji at Gunjan.Banerji@wsj.com

(END) Dow Jones Newswires

July 09, 2017 19:50 ET (23:50 GMT)