From the January 01, 2010 issue of Futures Magazine • Subscribe!

Flash orders under attack

Options leaders are speaking out against an SEC proposal that would ban flash orders on equities and options. On Sept. 17, the SEC proposed the rule amendment that would eliminate the flash order exception from Rule 602 of Regulation NMS under the Securities Exchange Act of 1934. According to an SEC release, if adopted, the proposed amendment would prohibit all markets, including equity exchanges, options exchanges, and alternative trading systems, from displaying marketable flash orders.

“Most of the comments were describing how the options industry is structurally different than the equity industry and how flash orders benefit investors. They keep costs lower for retail investors,” says Peter Bottini, executive vice president of trading at optionsXpress.

Options exchanges flash orders to their market makers before routing them to another exchange based on the national best bid offer (NBBO) price. That way the customer order could be filled more cheaply than if it were routed to an exchange that had a “maker/taker” fee structure. Also, the flash order rules may restrict or even eliminate price improvement auctions in the options market, according to Mark Longo of TheOptionsInsider.com, who says the SEC has been vague on the issue. “If price improvement auctions are restricted or eliminated as a result of this crackdown, it would be a terrible development for options customers,” he says.

Indeed, in its comment letter to the SEC, CBOE said “the proposed ban would inflate costs for those the ban seeks to protect, retail investors. A ban would limit trading venue choice and have an adverse impact on investors, particularly in the listed options market.”

The International Securities Exchange was more candid in its letter to the SEC. “We do not understand how a practice the Commission has blessed over the years, for which the Commission can cite no actual harm, and for which there seems to be fewer issues in today’s automated trading environment than on manual floor-based markets, suddenly has become an issue of such critical importance that the Commission has accelerated a proposed ban prior to addressing other market practices. It seems that unfounded populist sentiment, further fueled by political and competitive jockeying, has driven much of the current flash order controversy,” the letter said.

Bottini says that the SEC is expected to comment on their proposal and make an interpretation on their decision sometime in January.

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