BOX Options Exchange and its CEO Ed Boyle surprised the trading world recently by announcing that the mid-level options exchange would build a new trading floor in Chicago.
“It is not as crazy as it sounds,” Boyle told Modern Trader. “It is really an effort to understand market structure. Options can have a very sophisticated trade structure. A large firm may have a large position that they need to negotiate at the large desks upstairs.”
While options trading has mostly moved to various electronic venues with the exception of index options contracts traded on the Chicago Board Options Exchange under exclusive licensing agreements, there is a small but significant niche on complex orders that are traded — or at least introduced — in the open outcry environment.
There are 14 official U.S. options exchanges, run by five separate exchange operators, four of which have an open outcry floor. No retail customer orders trade in the non-electronic markets. The floor markets are not by rule exclusive, but by structural design only used for institutional orders, Boyle explains.
In order for a trade to clear at the Options Clearing Corporation, the order has to be exposed at one of the 14 options exchanges — in equities, exposure is not a requirement. You can match a trade between two participants and print it to the trade reporting facility without any exposure to the market as long as it meets the requirements of the markets (national best bid/offer).
The institutional trader wants to expose the order to the marketplace to print the trade but has a problem. “When he does it in the electronic marketplace, he loses control of his information,” Boyle says. “Once that information is distributed into the electronic market, all the algos read it and respond to it accordingly and that can impact liquidity.”
This was the common buyside concern back in the day. “A firm sends a sell order down to the NYSE and suddenly all of the buyers disappear and turn into sellers in front of him,” Boyle says. “Leakage of information is a huge problem with buyside clients. Trading floors allow for limited leakage of information.”
Here is what typically happens. “Picture a trader at an endowment has an options position that consists of six different legs that vary in size; one might be
960 contracts one might be 10,080 contracts, so on. The trade has a total notional value of $56 million, so he goes to a sell-side broker and says ‘I got this order and I want to sell this position.’ The broker will call around to liquidity providers (Goldman, Morgan CITI — institutional market makers) and say ‘I have this customer, he has got these six legs’ and those guys come back and give him all kinds of bids,” Boyle explains. ”He is going to assemble it upstairs. Now he has the difficulty of printing it. He now has two sides of the trade and puts that into an electronic market and when he does that he can’t print it as a single trade because there is no structure in the option market that lets him trade it as a single position. So, the complexity is what requires the trading floor environment. Instead, he goes to the trading floor and says I am willing to facilitate this position, I am crossing these with these, total value is going to be this, this is how I am pricing all these options. Market makers on the floor respond and are entitled to participate. Then it gets assembled and put up like that.”
So, that is why some orders are still traded on the floor. And, while it is not a huge amount of volume, it is significant. “If we forget about the proprietary contracts at CBOE and just talk about equity options between the four exchanges (no one keeps official stats), on any given day approximately 15% to 18% of the overall options business may be on trading floors,” Boyle says. “It is all done in large lot trades, many of them are facilitated.”
BOX, an exchange that has been around for 15 years, has always been in the second division of options exchanges market-share wise and would like to get some of that action.
It is building a floor in the Chicago Board of Trade building that will be able to service 35 to 40 market makers and is accepting applications. Boyle says current members will need an additional floor registration and that he has received strong interest.
There is a reason why some orders are still executed on the floor and BOX wants in.
“This is really just an effort to service the options business,” Boyle says.