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04:54 PM
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CBOE to Allow Screen-based Market Makers to Stream Quotes

The Chicago Board Options Exchange is going to let traders stream quotes without being physically located on the floor. It's all part of the CBOE's hybrid trading model, which is preparing for phase two just as its rival, the all-electronic ISE, announces an IPO.

In a move to compete with electronic options exchanges, The Chicago Board Options Exchange (CBOE) selected seven firms to function as electronic-Designated Primary Market Makers (eDPMs) that will stream quotes electronically without standing in the open-outcry trading pit.

This new membership class is part of the second phase of CBOE's Hybrid Trading System, known as Hybrid 2.0, which is expected to begin during this summer.

The seven firms include Citadel Derivatives Group, Citigroup Global Markets, Knight Financial Products, SLK-Hull Derivatives, Susquehanna Investment Group, Timber Hill and Wolverine Trading.

"EDPMs will compete head-to-head with floor members, which are made up of market makers and DPMs," explains Ed Tilly, vice chairman at CBOE, who also expects market quality and depth-of-quotes in terms of size to increase as a result of streaming quotes.

At the same time, CBOE is also introducing a second membership category known as remote market makers or RMMs, who will also compete with DPMs. (The distinction between eDPMs and RMMs is that eDPMs are entitled to participate in a certain percentage of the order flow, whereas RMMs and the regular market makers are only entitled to participate according to whoever is first with the best bid or offer, says a spokeswoman.)

"The RMM and DPM class do not have to physically be located on the floor of the CBOE," says Tilly. "They can stream their quotes from a remote location. That's a huge change for us as a floor-based organization," adds Tilly.

On Monday, the International Securities Exchange (ISE), the first electronic options exchange, said it plans to issue shares of its stock in an initial public offering. The success of the ISE has pushed traditional-floor based exchanges such as CBOE to respond with hybrid models that marry the speed of electronic trading with the benefits of open outcry. But one analyst is skeptical about whether the hybrid model is really better than either open outcry or electronic markets.

"The bottom line is, does the hybrid model work and what is the advantage of the hybrid model vs. the fully electronic model vs. the floor-only-model?" says Sang Lee, manager of the securities and investments practice at Celent Communications.

So far, the new eDPM class is attracting firms with expertise in screen-based trading. Two of the seven participants in CBOE's eDPM program, namely Citadel and Citigroup, have not been involved in floor-based exchanges, but they have expertise as screen-based specialists, says Tilly. For example, Citadel is an ISE member and a very aggressive market maker in terms of quoting, says Tilly. While Citadel has not been involved in floor-based exchanges, they've been involved in market making from remote locations. In Citigroup's case, it operates a "great" upstairs trading desk to provide liquidity to clients, "but they've never been in the market maker or specialist footprint. This is their first experience," says Tilly. As for the other participants, they have employed both floor trading and screen-based trading. For example, both Wolverine and Timber Hill are already at the CBOE, participating in both the screen-based and open-outcry aspects of hybrid trading, but they are going to expand, says Tilly.

Celent's Lee also questions whether the hybrid model is a permanent step for CBOE. "Yes, CBOE has now moved into the hybrid model, but is that a permanent solution for them?" asks Lee. "What will happen if they continue to lose market share, and if ISE builds on the momentum they've had the last couple of years," he suggests. "I wouldn't be shocked if CBOE goes completely electronic," he says.

But Tilly says the CBOE is not going to tell traders how to execute their orders, but is giving them a choice. Under the Hybrid Trading System, the person with the incoming order can choose to stream in quotes and point and click to execute an order, says Tilly. "What you can also do is elect to be represented in open outcry," which is done for complex orders and orders seeking liquidity, he says. "We've not eliminated open outcry," he adds.

According to Tilly, 70 percent of the CBOE's orders are routed electronically and are traded without open outcry. That's not to be confused with contracts, he says. There's a 50/50 split between options contracts traded on the floor and traded electronically, Tilly says, which indicates that the largest orders are still executed via open outcry. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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