Citadel Investment Group LLC, Chicago, the $22 billion hedge fund manager, is urging regulators to cap a new pricing system for options trading that could translate into higher costs for institutional investors needing to hedge their portfolios.
At issue is the “maker-taker” model, created by electronic communications networks fighting over market share in equity trading. The system hands out rebates to participants posting orders on a given venue — those who “make” the market — but charges a hefty fee to investors trading against those orders — or those who “take” liquidity away.
NYSE Arca Options, a division of NYSE Euronext, New York, introduced the maker-taker pricing system last year and just raised both rebates and fees.
Institutional investors are almost always liquidity takers, as they trade against buy or sell orders posted on exchanges. As takers, they may end up being charged higher commissions by their brokers to reflect the higher exchange fees the brokers must pay.
“If I am a fundamental investor in S&P 500 stocks and I want to buy a lot of puts to hedge my positions, I would generally buy those puts by taking liquidity, not quoting passively. As a result, my orders would be hit with higher fees and would be unlikely to earn rebates,” John Nagel, managing director and deputy general counsel for Citadel, said in an interview.
Executives at Citadel, the parent of leading options market-maker Citadel Derivatives Group LLC, take the issue so seriously that on July 15, they formally petitioned the Securities and Exchange Commission “to limit the fees that options exchanges may charge to non-members to obtain access to quotations to $0.20 per contract.”
The next day, Arca, the fourth-largest of seven U.S. options exchanges, raised its taker fees to 55 cents per contract, up from 45 cents, to support higher rebates of 35 cents to 40 cents, up from 25 cents. These fees apply to highly liquid options quoted in pennies, which attract a lot of trading activity.
Regulators quickly reacted to Citadel's petition. On July 17, Erik Sirri, the SEC's director of the division of trading and markets, asked the Securities Industry and Financial Markets Association's options committee to consider the cap proposal.
“What we are really after is to make it a fair and transparent market for the client, with a fee structure that is not excessive to the marketplace or creates confusion for the investor,” said Christopher Nagy, managing director at TD Ameritrade Holding Corp., Omaha, Neb., and a member and past president of the SIFMA options committee.
Two other exchanges have emulated Arca's maker-taker model: the Boston Options Exchange, which has a 5.8% market share; and the Nasdaq Options Market, launched on March 31.