According to new research from TABB Group, “Equity Options: Transparency and Simplicity are Clearly Not the Same,” with no dark pools, hidden trades, internalisation schemes, and each execution hitting the tape being posted on a licensed and regulated exchange, trading in US equity options has propelled volume to more than 15 million contracts a day in May 2018 alone, as retail customers and firms continue to enter the space.
Larry Tabb (pictured), founder and research chair at TABB, who co-wrote the report with contributing analyst Alicia Reilly, warns that between the 15 exchanges, different matching methodologies (pro-rata and price time) and different pricing models, maker/taker and taker/maker, which exchange an options trade is routed to and how that order is routed can be very impactful to the traders’ performance.
“Transparency in the options industry isn’t very transparent,” he says. “While pricing is complex, exchanges do layer on pricing tiers that can change the economics of a trade even further if your broker passes those benefits back to the client. Even when you believe you’ve mastered how to route your order, there can be price improvement agreements between clients, brokers and market makers to provide additional price improvement for beneficial order flow.”
Delving into nearly a dozen key trading issues, Tabb asks that as exchanges begin to offer Volume Incentive Programs (VIP plans) to attract liquidity in their proprietary products, “Are we potentially looking at a new pricing structure on the horizon?” explaining that these programs are directed at customers with their own frequent trader identification number (FTID) that rebates them based on their volumes. “Traders that care need to understand these dynamics, along with all the other models, or they will never understand how they’re being charged, their true cost or their true alpha.”
In this age of price and fee compression, knowledge becomes critical to understanding your alpha and increasingly their value in the investment chain. “The bottom line,” Tabb says, “is to be very careful by understanding what you are trying to accomplish with your order, ensuring that you and your broker’s expectations are aligned and managing and measuring your execution performance carefully. Otherwise, what you get may not be what you expected. Caveat emptor, always.”
The 17-page, seven-exhibit report examines market structure and the cost of trading options, exchanges and their pricing structures, complications of tiering, market-maker preferencing and routing, best execution and regulations.