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New Options Exchange Opens for Business

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The Gemini┬┐ options exchange opened for business today. Owned by the International Securities Exchange, GEM represents the 12th U.S. options exchange and opened this morning with six listings: Disney (DIS), Dow Chemical (DOW), Goldcorp (GG), NetApp (NTAP), NVIDIA (NVDA), and Texas Instruments (TXN). If all goes according to plan, Gemini will ramp up that number over the next several weeks until the exchange is trading all of the most actively traded options classes. This exchange stands "side-by-side" with the existing options exchange and, according to the ISE, was created to "offer member-firms a choice of market and pricing models." Why would an existing electronic exchange launch a second electronic exchange? The answer is pricing models (maker-taker vs. traditional fee-based pricing) and the economies of shared technology, routing, compliance and administration.

Gemini is just the latest move by an options exchange to increase their market share. While overall industry growth has leveled off in recent years, the competition for flow has never been more intense. The Chicago Board Options Exchange (CBOE) continues to hold the largest market shares (thanks in large part to their exclusive listing of popular CBOE Volatility Index (VIX) and (SPX) index products). ISE, PHLX, ARCA and AMEX are among the bigger players as well. New OCC clearing procedures designed to curb the dividend-related call volume will go into effect later this year, with PHLX likely to suffer unless they can attract some replacement flow.

Options exchanges are trying to attract orders by offering new bells and whistles. For example, ISE's complex order book has been well-received tool for matching more advanced strategies like spreads and straddles, while their 'implied order' functionality creates cross-liquidity between the COB and outright markets. PHLX has launched exchange-traded options on Treasury Securities. Not all ideas work out, however. The highly debated Jumbo Spiders (SPYJ) on the Boston Options Exchange, for example, have failed to win over the options trading community and currently see a whopping 36 contracts of average daily option volume.

The drive for market share and innovation can be a double-edged sword for end-user investors in the options market today. On one hand, new tools can improve pricing and execution. At the same time, the added complexity and fragmentation creates expensive challenges to participants, particularly at the large-size institutional end of the market. Efficiency has reduced the number of liquidity providers in the options market, and the proliferation of exchanges means the remaining market-makers must post their liquidity in disconnected 'pools' - now counting 12. Thanks to routers that allow investors to "sweep" orders across multiple exchanges, the fragmentation typically isn't a problem for retail traders. However, when large 'whale' trades surface, or during periods of heightened volatility, the absence of a few deep liquidity pools can become an issue.

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At the time of publication, Henry Schwartz held no positions in the stocks or issues mentioned.


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