"It's about time," is probably a phrase being tossed about Wednesday morning by more than a few in the options industry on a bit of
news out of the
Securities and Exchange Commission
The SEC announced Wednesday it will conduct a study on the development of payment for order flow and internalization in the options market and any changes in market quality since the multiple listing of options.
The practice of options specialists and market markers paying brokerage firms for their orders has become a hot-button issue in the market community, and as it has become widespread, the effort to ensure the quality of the markets is damaged.
The SEC, according to its news release, is trying to figure out the "nature, scope, and prevalence of these arrangements and their influence on order routing patterns" and "attempt to determine the effect of these practices on quote competition, spreads and execution quality."
The regulators are watching now "because payment for order flow and internalization is a new development in the options market, the data from the previous year may offer a unique opportunity to isolate and examine causal relationships between the practices and changes in execution quality."
The SEC said it plans to make its findings public in November.
The SEC added that it wouldn't ban the practice, explaining that it "is extremely reluctant to take action that would prescribe the form of intermarket competition."
Over the past year, the options business for both market makers and exchanges has changed dramatically. With the advent of multiple listing of options, competition among market makers for order flow has increased sharply.
Also, because of multiple listings, spreads have narrowed, helping to squeeze profits for market makers. To make up the difference, market makers and specialists want more order flow to come their way. And because of that intensified competition for volume, the practice of payment for order flow has sprouted.
Many in the options industry abhor the practice of payment for order flow, with some likening it to a kickback. Some in the industry have hoped that the SEC would prohibit payment for order flow altogether, because they think it can affect the execution of trades at the best price.
In a conference call after the release of the company's earnings Wednesday, Kenneth D. Pasternak, the CEO and president of
Knight Trading Group
Knight Financial Products
unit has quickly become a sizable player in the options business, said the firm has started a payment-for-order-flow plan.
Knight said its option market making business generated total net trading revenue of about $37.8 million in the second quarter.
Critics of the practice of payment for order flow argue that it provides incentives against finding the best price for execution and price improvement on orders because the final destination of the order is determined by the payment arrangement.
So, for example, critics charge, that an individual investor sending an order to their broker, which accepts payment for sending orders to a specific market maker, may not get the price for an order or at least price improvement, because the orders are only going to that one market maker.
The good news for individual investors is that brokerages are demanding from market makers best execution and the market makers need to prove they are offering best execution with cold, hard data, according to one options industry source.
Brokerage firms are required to tell clients annually in writing whether they receive payment for order flow and if they do they must provide a description of the type of the payments. Brokerages must also disclose on trade confirmations whether they receive payment for order flow. Customers can also make a written request to find out the source and the type of payment on a particular transaction.
However, "frankly, very few customers want to write in" to their brokerage firms to find out, says John C. Coffee, Jr., a law professor at
The SEC announcement comes in the wake of announcements of payment for order flow programs by some options exchanges. (
has reported on payment for order flow programs at the
Chicago Board Options Exchange, the
American Stock Exchange and the
Philadelphia Stock Exchange.
Robert Half International
has been catching the eyes of some options industry analysts lately.
Lillian Seidman, half of the Seidman-Skupp options team at
, noted that implied volatility on Robert Half's front month options was phenomenal at 120, about double its normal levels. She pointed out that the increase comes ahead of the company's earnings report, slated to be released Thursday.
Implied volatility is the annualized measure of how much the market thinks a stock or index can potentially move and is a critical factor in an option's price. When market makers raise implied volatility, they are expecting bigger movement in underlying securities' price, either up or down. Implied volatility readings often rise ahead of market-moving news in a stock, like earnings.
Seidman also noted that there was higher-than-average trading in Robert Half's stock on Friday, Monday and Tuesday.
"It looks like they're going to report good numbers," she said.
Volume in the options was light Wednesday, with all of the trading done in the call options on Robert Half. On Tuesday, a total of 538 options on Robert Half traded, 520 of which were call options, compared to average volume of 130 contracts, according to
Robert Half's stock has had a nice run in 2000, and especially in July. On June 30, it closed at 28 31/64 and closed Tuesday at 34 3/8. However, it was trading down early Wednesday afternoon, off 5/16 to 34 1/16.
First Call/Thomson Financial
16-analyst consensus estimate is projecting Robert Half, a specialized staffing services company, will report second-quarter earnings of 23 cents a share.