May 5 (Bloomberg) -- Smaller U.S. options exchanges that don’t attract a minimum amount of trading should withdraw from an industry agreement that prevents rivals from ignoring them when they have the best prices, according to Nasdaq OMX Group Inc. Chief Executive Officer Robert Greifeld.
Greifeld made the suggestion to counter the increased technology costs to brokers and investors resulting from market fragmentation as more exchanges enter the business. U.S. options trading across the current nine exchanges reached a ninth straight annual record last year with 4.56 billion contracts changing hands, according to data compiled by Chicago-based OCC.
The Nasdaq OMX CEO’s idea was rebuffed by executives at competing exchange operators including NYSE Euronext and CBOE Holdings Inc., highlighting a rift over whether there should be limits on the number of exchanges or efforts to curtail markets with less trading. Three more options markets are planned for this year, including one from Nasdaq OMX that will give the New York-based company its third.
“How many options markets are too many?” Greifeld said today in a speech at the annual options industry conference in New Orleans. “Is nine enough? Is it 19, 29 or 39?” he asked. Exchanges should bring “some differentiated advantage to the marketplace,” he said.
Greifeld’s competitors CBOE Holdings, which has the largest share of options trading, with 28.4 percent of all volume last month, and NYSE Euronext each have two exchanges for puts and calls. NYSE Euronext’s venues have a combined 23.8 percent market share and Nasdaq OMX’s pair have 24.5 percent, according to OCC, which clears and settles all equity derivatives trades on exchanges. Three exchanges had less than 4 percent of volume last month, the data show.
An exchange that doesn’t get at least 3 percent of volume within two or three years should move out of the so-called options linkage plan, which includes all nine markets, Greifeld said. The Options Order Protection and Locked/Crossed Market Plan, approved by the Securities and Exchange Commission in 2009, ensures competition by requiring exchanges to have policies that prevent trades from occurring at prices that are inferior to the best bids and offers available elsewhere.
Exiting the options plan “would isolate an exchange and customers wouldn’t be able to easily access the quotes on that exchange,” William Brodsky, chief executive and chairman of CBOE Holdings, said in an interview at the conference. That would make it harder for a venue to compete for orders, he said.
CBOE Holdings runs the largest and smallest venues by market share. The Chicago Board Options Exchange had 27.1 percent of volume last month while C2 Options Exchange claimed 1.3 percent. Brodsky said an arbitrary number shouldn’t determine whether an exchange is “in or out of the options plan.”
Exchange companies construct trading rules and pricing models to entice different participants, sometimes targeting individual investors, market makers or brokers interested in trading a larger number of contracts at one time. They may use different methods for matching orders, provide services tailored to certain types of firms, or compete by offering electronic systems instead of trading floors.
Greifeld’s idea poses challenges, Steve Crutchfield, chief executive officer of NYSE Amex Options, said in an interview. It appears to conflict with the SEC’s effort to encourage competition among exchanges and could give venues an incentive to “accumulate market share at any cost just to meet the target,” he said.
‘Plethora of Marketplaces’
“We don’t want to retard the ability for innovation or attempted innovation to happen,” Greifeld said in his speech. He added that while competition has decreased investors’ cost of trading in recent years, technology expenses may shrink those benefits. “With the requirement to honor all the electronic quotes in the marketplace, it can get to a point where there’s really a plethora of marketplaces,” he said.
Nasdaq OMX will introduce its third options exchange next month if the SEC approves its rules. The venue will initially match buy and sell orders using methods similar to those for Nasdaq Options Market. Unlike that exchange it will employ pricing that pays firms trading against existing orders instead of charging them a fee and is likely to appeal to brokers handling retail orders, Thomas Wittman, head of the company’s U.S. options business, said today.
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Greifeld didn’t comment on whether his suggestion should apply to U.S. equities where there are 13 exchanges and a 14th is being planned. Nasdaq OMX’s slice of the 6.8 billion shares that changed hands daily in the first quarter was 21.4 percent across its three U.S. stock exchanges, according to data compiled by Barclays Plc.
The options industry should consider whether more exchanges are worth the costs they entail for participants, Joseph Gawronski, president and chief operating officer at New York- based Rosenblatt Securities Inc., said in an interview in New Orleans.
“Perhaps there should be some threshold of differentiation required before a new entrant is allowed into the plan,” Gawronski said. “Or maybe the exchanges should consider some type of arms treaty where each exchange group agrees to be limited to two exchanges.”
Most of Nasdaq OMX’s competitors in the options business disagreed with Greifeld’s suggestion to curb the contest between exchanges.
“Market share is not the measure of a successful exchange,” Gary Katz, president and CEO of the International Securities Exchange, said in an interview. “I don’t support saying that an exchange cannot continue if it doesn’t reach what its competitors deem to be minimum thresholds. The exchange may be providing services that its customers consider valuable and it could be at a very low market-share threshold.”
ISE, the third-largest options exchange with 16.3 percent of equity derivatives volume, plans to introduce a second market by the end of this year.
Jeromee Johnson, head of the options venue run by Bats Global Markets Inc. in Lenexa, Kansas, and Anthony McCormick, CEO of Boston-based BOX Options Exchange, said in interviews that they didn’t support Greifeld’s approach. Bats Options claimed 3.1 percent market share in April and BOX had 3.9 percent, according to OCC.
“It strikes me as anti-competitive to say you have to reach a minimum market-share threshold or be dropped from the industry linkage plan,” McCormick said. “If you have a business model and want to bear the cost, the market will decide whether you last as an exchange. Who made him the decider?”
He added that “it’s disingenuous to talk about introducing market models that don’t add value,” referring to the proposed rules and pricing of Nasdaq OMX BX Options that are a similar to BOX’s.
“There has to be some finite limit in terms of the number of markets,” Greifeld said. “It can’t be infinite.”
--Editors: Michael P. Regan, Nick Baker