Very informative article on the state of option exchanges, but what is your personal take on the future of a "human presence" on the floor of the CBOE Chicago Board Options Exchange? Do you think that CBOE Chairman and CEO Bill Brodsky will succeed in maintaining the presence of the human element on the floor or are the market makers on the floor a dying breed? -- N.S.

I think the type of independent market makers who used to constitute much of the "crowd" for equity options on the floor of the CBOE are very much an endangered breed, if not a dying one.

As the Feb. 2 column says, even on the CBOE, the majority of orders are placed and executed electronically. While Brodsky is committed to maintaining a physical floor presence, he is very clear in acknowledging that ultimately the future (and pretty much the present) of exchanges and trading facilities lies in offering off-floor and remote market-making platforms.

As advances in technology make it not only possible but more efficient to enter and execute complex orders electronically, the need for live brokers will diminish. The combination of linkage between exchanges and improvements in software now provides investors with the ability to place some basic multileg orders such as buy-writes, spreads, butterflies and straddles as a single transaction.

Market makers and specialists are no longer needed to maintain a separate "spread book," or make markets for an unlimited number of combinations. Instead, new software can scan the National Best Bid and Offer (NBBO) across all of the exchanges and piece together the best price possible for executing a complex order.

In the past, a complex order might have sat on the separate spread book waiting for traders to match up. Now, investors can get multileg orders filled much more quickly, at better prices, with greater frequency and without the risk of legging into the position. This is enabled by smart technology that allows a fill at the best or designated price by combining existing and oftentimes separate standalone orders from different exchanges.

But the individual investor's gain is the market maker's loss. The area of spreads and other complex orders was one of the remaining areas where a human presence added value and in which the market makers could establish a bid/ask market that gave them a distinct edge. Now that spreads can be "shopped" and partake in the NBBO, the edge of being a market maker is diminished.

This is why you see fewer independent market makers and considerable consolidation among the market-making and brokerage firms. The tighter margins make the return on owning or leasing a seat a relatively poor investment. Instead, what we see are the large firms becoming both the owners and the premier liquidity providers at the various exchanges.

Examples include InteractiveBrokers' equity stake in the Boston Options Exchange (BOX); the recent purchase of the Pacific Exchange (PCX) by Archipelago, in which

Goldman Sachs

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are major investors; and


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purchase of Spear Leeds' specialist operations to gain access to its electronic platform to better service institutional clients.

As pricing, market making and price dissemination become commoditized products and services, it will be harder for individuals, firms and exchanges to operate these businesses as distinct entities. Ultimately, I expect technology and economies of scale will result in the elimination of most physical trading floors and live market makers; both will be consolidated under the virtual roofs of the largest firms.

I am gauging the value of tracking large block trades in SPX options. My data show that on Thursday, Jan. 27 at 11:08:50 a.m., 4,000 Feb. 5 1150 calls (SPTBJ) traded at $31. These calls were 26 points in the money and represented a value of over $12 million, a large trade by any standard, I would think. Of course it can be part of some combination order, but that is not the issue here. The issue is that bid/ask at that time was 29.8-31.8, so the bid/ask average was 30.8. It puzzles me how such a large order can be filled so close to the bid/ask average. Assuming this was a buy, wouldn't such an order be filled, at least partly, much closer to, or even above, the current ask? (And of course similarly closer to the bid in case of a sell.) Or is this a "quantity discount" by market makers? -- RVDB

My initial guess would be, as you suggest, that this trade was done in combination with the underlying index, futures or basket. This would help the two sides meet in the middle of the bid/ask because it would represent a fairly hedged position rather than an outright purchase or sale. An outright purchase or sale would force the other side to go into the open market, possibly into other options, in which case spillover volume would have appeared in other strike prices, or into the futures or underlying shares to lay off the risk.

If that were the case, you would be correct in thinking that a market maker might demand a bigger edge -- that is, a price closer to the bid to compensate for the risk, however momentary, that's carried by facilitating such a large transaction. The market maker would want to know that he has a sufficient edge to not only lay off the risk, but lock in a profit.

This is the kind of trade Brodsky would be proud to show as an example of live brokers providing depth, liquidity, expertise and the assumption of risk. But I have a feeling the trade was shopped upstairs too and had another institution, not a local market maker, taking the other side. The trade may get recorded as having been executed on the floor, but the open outcry system did not really facilitate the trade.

Given that the trade was not only for a deep-in-the-money option, but likely hedged in some fashion, I'm not sure it provides much insight or predictive value.

Steven Smith writes regularly for In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to