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Options Market Plugs Away

Traders Magazine Online News, September 22, 2017

Terry Flanagan

This article first appeared in the magazine of the STA’s 84th Annual Market Structure Conference, which was held Sep. 13-15 in Washington, D.C.

For exchanges, trade handlers and technology providers, the U.S. options market recently has been the equivalent to a three-star restaurant review on Yelp: the meal was okay, it had its moments and there was no big problem, but overall it wasn’t anything to get excited about.

The issues keeping options from four or five stars have been pretty much the same for several years now.

Flat volumes. A fragmented marketplace. Liquidity challenges. Subdued market volatility. Increased operating costs.

“A lot of people are in bunkers,” said Paul Jiganti, managing director at electronic market maker IMC Financial Markets. “If you’re not trying to acquire or be acquired, you’re just trying to shore everything up until there’s a more lucrative marketplace.”

Average daily options volume for the first half of 2017 increased 1% to 16.6 million contracts, according to OCC. Numbers for the preceding full years are strikingly similar: 16.4 million contracts per day in 2015, 16.9 million in 2014, 16.3 million in 2013.

Optimists note the big picture, which is that options volumes remain near record levels reached in 2011. This means that the heady gains of 10-20% per year in the mid/late 2000s were not given back.

But much of the options build-out over the past decade was predicated on expectations that the market would continue to expand, at least modestly. So the flatlining of the past few years has put many market practitioners back on their heels.

“Niche firms should be doing okay, and the really big firms that have economies of scale are making a go of it,” Jiganti told Markets Media. “But the small, non-niche firms — the old-fashioned market makers — are having a rough time.”

Order Flow Wanted

Market makers are indeed feeling the squeeze. There isn’t enough order flow from end users to keep everyone busy; liquidity is dispersed over 15 exchanges, up from 10 five years ago; and an increase in systematic trading, as well as a persistent lack of volatility, have served to constrain profit opportunities.

Interactive Brokers Chief Executive Thomas Peterffy, a 40-year market veteran and a pioneer of electronic market making in options, was remarkably candid in explaining IB’s decision to exit market making by selling its Timber Hill unit to broker-dealer Two Sigma Securities.

“It’s been painful for me to see it deteriorating in the last few years,” Peterffy said in a March 8 press release. “But we do not have a choice in this matter. Today retail order-flow is purchased by large order internalizers and joining them would represent a conflict we do not wish to have. On the other hand, providing liquidity to sophisticated, professional synthesizers of short-term fundamental, technical and big data is not a profitable activity.”

On the flip side, Two Sigma Securities’ purchase underscored its own optimism that the options industry is worthy of investment. Aside from integrating the business and Timber Hill employees, TSS Chief Executive Thomas Yates said, “We will also be actively engaging with the exchanges, other market participants and regulators to be part of the dialogue around growing a healthy options industry.”

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