In E-Trading Competition, Options Customers Win

In Wednesday's column I looked at the structure and regulation of the options industry. Today I'll focus on product listings and trade execution issues.

The two events that have had the biggest impact on options trading are dual listings (allowing one contract to trade at multiple exchanges) and electronic trading. Even though they came from different directions -- the former a child of government regulation and the latter from free-market competition -- both are technology-driven and have gained in popularity because of their efficiency and fairness. While this has led to more transparent, tighter markets and lower costs, it also presents new challenges for the exchanges and members.

Share Fare

"When [former SEC Chairman Arthur] Levitt mandated dual listing of contracts, that created competition, but it did not foster communication," said OptionXpress CEO Ned Bennett. While in theory customers would receive more competitive bid/ask spreads, exchanges were not required -- nor did they have much incentive -- to match each other's quotes.

Part of the problem was the practice of payment for order flow. This essentially amounted to either a kickback process to entice firms to direct business toward a particular exchange, or "rebates" to member firms that offered discounts to garner business. Whatever the label, the practice had been viewed as a necessary evil: As quickly as one exchange succumbed to the perception that the practice was anticompetitive and created conflicts of interest, another would reinstitute it to gain market share, forcing other exchanges to find ways to entice order flow back.

This practice will always be present in one form or another, whether it's specialists claiming they need incentive to carry risk, market-makers wanting subsidies for providing liquidity, or institutions looking for volume discounts.

Take My Price, Please

While brokerage firms should have always been looking to provide the best prices, the onerous burden of comparing markets often fell on the customers' shoulders. But now the process of scanning for the best bid/offer has been greatly simplified.

"Customers are now far more sophisticated and demanding than in the past. And technology and rules actually make it a lot easier for them to smart-route orders than it is for broker/dealers," said Tony Saliba, principal and founder of both First Trader Analytical Solutions, which provides the CBOE and Amex with front-end workstations, and LiquidPoint, which offers an electronic broker/dealer trading platforms to brokerage firms.