The U.S. options market is preparing for major changes that may be a mixed blessing for institutional investors turning more than ever to options as a means to mitigate risk or generate better returns.
On Jan. 26, the six U.S. options exchanges will embark on a pilot program to quote, in pennies, series of options on a dozen stocks and on the popular QQQ exchange-traded fund that tracks the Nasdaq 100 index. The plan, which Securities and Exchange Commission Chairman Christopher Cox advocated last June, will shrink the currently wider 5- and 10-cent quote increments.
Regulators hope that penny quoting ultimately will help reduce payment for order flow, or when a broker buys customers' orders from another broker to match them in-house, hopefully at a profit, instead of trying to get a better price for those orders.
Meyer "Sandy" Frucher, chairman of the Philadelphia Stock Exchange, expects "the penny pilot will answer a lot of the questions that people have speculated about for a long time. The answers will determine market structure and payment for order flow issues."
The PHLX is the third-largest U.S. options exchange, behind the Chicago Board Options Exchange and the International Securities Exchange. The other options exchanges are NYSE Arca, a unit of NYSE Group; the American Stock Exchange; and the Boston Options Exchange.
SEC Commissioner Annette Nazareth recently explained to an industry gathering the rationale for the move to pennies.
"Pricing inefficiencies caused by nickel- and dime-minimum increments correspond to a proliferation of payment for order flow practices and internalization arrangements. … The move to penny increments in equities greatly reduced spreads in those securities resulting in a commensurate decrease in payment for order flow," Ms. Nazareth said.