In the far, far away galaxy of options publications, you'll find numerous stories detailing the demise of the traditional options market-maker and specialist business. Some firms are consolidating, while others are completely abandoning floor operations. Bear Stearns ( BSC) is outsourcing its Chicago Board Options Exchange floor business, and Goldman Sachs ( GS) is slashing its Spear Leeds & Kellogg unit. Susquehanna International Group has relinquished its specialist book of 78 issues on the Pacific Exchange, and Toronto-Dominion ( TD) has shuttered its specialist business on both the Pacific and Philadelphia exchanges. The list goes on. Perhaps the main factor has been the growing success of the International Securities Exchange, or ISE, the 3-year-old all-electronic exchange, which is forcing the options industry into the 21st century. "I don't know how they do it, but the ISE definitely stands by the markets it makes," says Larry McMillan, president of McMillan Analysis Corp., whose firm runs an options-based hedge fund, oversees managed accounts and offers a variety of options-related research and newsletters. "They don't hide orders, and execution confirmation is immediate. These are two things that have been definitely helping them grab market share." Indeed, April marked the third consecutive month that the ISE was the leading options exchange in terms of volume and market share.
Necessary AdaptationFor some players in the options markets, these are tough times. "There are just very few issues whose options I feel offer a liquid market in which I can execute trades at a fair price," argues George Fontanills. And lest you think this is just another trader complaining about wide spreads and playing second fiddle to institutions, know that Fontanills runs the Pinnacle Appreciation Fund, an all-options hedge fund. But while Fontanills' lament may hit a chord with many traders and touches on some of the structural issues challenging the industry, his situation is exceptional -- the size of the orders he's talking about are 5,000 to 10,000 contracts. That would make him one of the largest options traders out there. Other professionals and money managers seem to be having better luck.
McMillan says that orders of up to 200 contracts can "typically be filled through exchanges without too much difficulty." And Mike Schwartz, the chief options trader at Oppenheimer, a division of Fahnestock, says that "most people's main concerns are tight markets
a narrow bid/ask spread and timely fills, not worrying about accommodating large-size orders, and the ISE is fulfilling that need."