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CBOE Bets Streaming Quotes Will Cool ISE

The Chicago Board Options Exchange is launching a hybrid-trading system with streaming market-maker quotes to counter its all-electronic rival.

In a move to recapture market share from its all-electronic rival, the Chicago Board Options Exchange is launching a hybrid electronic-trading system that allows for real-time streaming of quotes by individual market makers.

The new system, dubbed CBOEdirectHyTS — for Hybrid Trading System — is an attempt to win back market share from the International Securities Exchange (ISE), which recently climbed into the number one spot.

As of April, the ISE had 30 percent share of equity-options volume, followed by the CBOE with just over 26 percent, the American Stock Exchange with around 22 percent, the Philadelphia Stock Exchange with close to 11 percent and the Pacific Stock Exchange with a hair over 10 percent, according to the Options Clearing Corporation.

CBOEdirectHYTS, which was slated to go live at the end of May, is designed to provide the speed and efficiencies of a screen-based trading system, while preserving the liquidity and price discovery of a floor-based open-outcry market.

CBOEdirect — a standalone trading platform designed by the CBOE's technology department — is the underlying trading engine. Member firms can point and click on a bid and offer, and instantly execute against the displayed size.


"One of the reasons that the ISE became so successful so fast is because its displayed bid and ask spreads were tighter than our markets," says a CBOE source. That may be because the ISE had streaming market-maker quotes since inception.

At the ISE, 10 primary market makers and 130 competitive market makers input quotes. Liquidity providers include the largest securities firms — Morgan Stanley, Bear Stearns, Deutsche Bank, Lehman Brothers and Credit Suisse First Boston — that didn't participate as specialists in options previously.

CBOE knew that because it had 1,400 traders in the pits, it had to find a way to input their quotes, the source adds.

"When individual market makers or floor brokers have bids and offers that they want to reflect in the market, they verbalize (them) and they are captured by the quote reporters," explains Ed Provost, the CBOE's executive vice president of business development. "That is not nearly as efficient as each individual market maker being able to electronically stream his individual quote for every series and every class at the post," adds Provost.

Under the CBOE's specialist system, the designated primary market maker or DPM has responsibility for all the bids and offers that are sent out on the system and disseminated via the Options Price Reporting Authority (OPRA). "That auto-quote system only had enough bandwidth for one DPM in the pit to disseminate quotes," says the source.

With an auto-quote system, the option's derive their value from the underlying stock, so every time the stock price changes, that drives the auto-quote system to change the options price and results in a flood of data.

But that wasn't the only problem. A bigger problem was that if a market maker narrows the quote, and a trade comes in, the DPM would take the trade, so the CBOE market maker had no incentive to tighten the market.

"The incentive to better the market was virtually non-existent and that helped the ISE flourish in the first couple of months," says Jon Najarian, chairman emeritus of Mercury trading, a DPM on the CBOE and chief market strategist of PTI Securities. Not only that, the market maker had no reason to bark out loud to get his quote on the screen, because no one would know whose quote it was, he adds.

Now with HYTS, there will be an electronic trace or unique electronic identifier on the handheld used by the market maker. "Whoever is first with the highest bid or lowest offer will be entitled to get the trade. The market maker that posted the highest bid or lowest offer, he gets the reward he was always seeking, he gets the trade," says Najarian.

Provost says, "The system knows the identity of the bidder or the person offering, whether it be a market maker or the DPM, for an order in the central order book, so there is a greater alignment between who has improved the market and who is involved in the trade."

Meanwhile, a lot of the posted bids and offers on the ISE are from the competing market makers in the other exchanges, says Najarian. Because the CBOE didn't have this functionality, but the ISE did, its market makers were streaming their quotes to the ISE and helping to tighten the markets. Najarian says that the CBOE specialists estimate that between 20 and 40 percent of the ISE's volume comes from market makers standing in the pits of the other exchanges.

CBOE Taps Belzberg for Hybrid Trading

Customers may need to change their workstations if they lack point-and-click functionality when the Chicago Board Options Exchange (CBOE)'s new CBOEdirectHybrid Trading System goes live in late May.

The Chicago-based options exchange is promoting the CBOEdirectHyTS terminal in a joint marketing alliance with Belzberg Technologies, Inc.

The so-called HyTS terminal - made available to customers in March - is dubbed a point-and-click terminal because "people can point to the bid and offer that the CBOE is showing and they can buy or sell options," explains Ed Provost, CBOE's executive vice president for business development.

Firms that installed a CBOEdirect terminal for single-stock-futures trading a year or two ago, when CBOEdirect became the trade engine for OneChicago, already have the point-and-click functionality. But if firms don't have CBOEdirect, they're going to need the Belzberg terminal to take advantage of the advanced functionality, exchange officials contend.

HyTS is also being called a universal-access workstation because it not only provides access to all CBOE equity and index products, but will offer order routing to other U.S. options, futures and stock exchanges, as well as access to market data, streaming market-maker quotes and order management, all on a single screen.

The American Stock Exchange offers Total Access Options (TAO), an order-entry system for routing orders to all five U.S. options exchanges, which could serve as an alternative to HyTS for options.

However, brokerage firms, primarily retail firms, that send order flow to CBOE, will not have to change their systems.

"Order-entry firms who send us order flow can continue to use their normal order-routing connections to the CBOE," says Provost, or they can choose a different third-party solution. If they build their own technology, they can connect via CBOE's FIX 4.2 connection."

But that is unlikely because the combination of advanced functionality and pricing favors the HyTS terminal, contends Provost.

CBOE is providing Belzberg terminals for free for the first six months, and then $250 a month after that. Orders routed to CBOE are free, but there's a 10 cents per contract charge for orders routed away from the CBOE.

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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