Industry Preps for Penny-Options Jolt

The market data industry is bracing for more options market data traffic as the Securities and Exchange Commission prepares to begin quoting options contracts in penny increments.

SEC chairman Christopher Cox recently wrote to US options exchanges announcing a test period for penny quoting, beginning Jan. 29, 2007, "to study the impact of penny quoting on market quality and systems capacity requirements." The SEC has also scheduled a face-to-face meeting with the exchanges later this month, a source tells Inside Market Data.

Joe Corrigan, executive director of the Options Price Reporting Authority, which distributes options data, says OPRA will factor the results of the pilot into its capacity predictions, but is confident it can meet any new levels.

Manisha Kimmel, executive director of the Financial Information Forum, which monitors data volumes, says the pilot period should not cause any capacity issues. "The goal of the pilot is to allow us to properly study the impact without adding costs," she says.

However, the pilot will limit penny quoting to around 15 options classes out of a possible 1,500 or more, and others are already expressing concern about the effect on volumes when penny quoting is expanded across the options market.

"Penny pricing will be a nightmare of data volumes," says Paul Pickup, director of exchange IT consultancy Trading Tech-nology. "For every change of the underlying stock price, a whole series of options has to be re-quoted. For every stock there may be four series of expiries with five series of different options prices for each—so up to 20 that have to be re-quoted."

Danny Friel, chief information officer at the International Securities Exchange, says that ISE's tests suggest increases of 200 to 500 percent. And more price changes will make it easier to fill orders, leading to more quotes reflecting order size changes, he says, forcing exchanges to increase the capacity of their systems and networks.

But pennies could confuse and discourage retail investors by allowing professional traders to "penny jump" in front of their orders, warns Ned Bennett, chief executive of online broker OptionsXpress. Bennett also expresses concern that the sheer volumes will require onerous system rebuilds.

ComStock president Mark Hepsworth says the vendor will be able to carry the data—currently 60 percent of its entire feed—but is "more worried about customers.... Some parts of the market are already questioning their current data infrastructure costs."

However, one of the SEC's requirements is that exchanges also propose effective quote mitigation strategies. Eric Stockland, director of active data products at NYSE-Arca, says there are many workable ways to reduce quotes, and NYSE-Arca's tests have shown mitigation rates of between 20 and 30 percent, depending on the option series and expiration date.

But the SEC has already proposed the best mitigation strategy, says William Easley, president of the Boston Options Exchange, by introducing penny increments only under $3 and keeping nickel and dime increments above that price. "It's what we would have proposed—it gives you pennies where you most want them but limits traffic growth where you don't want it," he says.