BOX breaks rank - small market makers have a chance again

[nitro]

http://www.tradersmagazine.com/issues/20_287/102250-1.html?zkPrintable=true

I hate options PFOF, since it doesn't typically go into the pocket of the maket taker. Eliminate all of these fees/incentives. Let exchanges compete strictly on price and convenience. Let the consumer route to the exchange of preference. This makes things as simple as possible, but not simpler.

Note the high profile people fighting in this arena. There are scores more of boutique firms behind the scenes that stand to lose or gain based on what gets decided, if anything.

If PFOF stands in the options market, enact a law that says the customer MUST receive that payment, not the Broker Dealer.

...For NYSE Arca Options, access fees and payment for order flow are two sides of the same coin. "When a liquidity provider pays for order flow, that's a cost and it must come from some place," said Ed Boyle, head of Arca's options market. "That place is the spread in the market." In a maker-taker model, in contrast, the liquidity provider gets a rebate, so the spread in penny names can often be tighter. "The customer pays to take liquidity, but the benefit he gets is a tighter spread," Boyle said. "It's a tighter spread because the people providing the spread have a revenue stream coming toward the rather than a revenue stream going out...."

Why on earth is this so hard to understand? Guess what, it isn't. The reason it is not law is that B/Ds eat the PFOF with zero risk to them. This is equally if not more lucrative than the comission they charge a customer! In fact, I am surprised there aren't any free comission option brokers out there. It is a scam.

 

[nitro]

black diamond,

Sorry I forgot to quote this. See above post in response to your post.

Quote from black diamond:

Nitro - I am curious why you think payment for order flow is bad. Do you think this is true in general?

I would think if a market can increase volume by getting more market orders they should pay for order flow. If they need more limit orders they should give a rebate for providing liquidity. Why shouldn't the exchange determine what they need more of and pay for it? And if one market wants my order flow more than another why shouldn't they pay me for it?

I do agree with you that the restrictions on providing liquidity seem weird though. I understand the argument that they are paying some designated MM's by giving them pseudo monopoly powers so they will be there when others aren't but that seems extreme unless they have some really heavy duty obligations.

 

[black diamond]

Quote from nitro:

http://www.tradersmagazine.com/issues/20_287/102250-1.html?zkPrintable=true

I hate options PFOF, since it doesn't typically go into the pocket of the maket taker. Eliminate all of these fees/incentives. Let exchanges compete strictly on price and convenience. Let the consumer route to the exchange of preference. This makes things as simple as possible, but not simpler.

Note the high profile people fighting in this arena. There are scores more of boutique firms behind the scenes that stand to lose or gain based on what gets decided, if anything.

If PFOF stands in the options market, enact a law that says the customer MUST receive that payment, not the Broker Dealer.


Why on earth is this so hard to understand? Guess what, it isn't. The reason it is not law is that B/Ds eat the PFOF with zero risk to them. This is equally if not more lucrative than the comission they charge a customer! In fact, I am surprised there aren't any free comission option brokers out there. It is a scam.

Thanks for the reply. I understand, I just don't agree.

You might be right about what rules the exchange should choose but I don't think things like that should be mandated without a strong reason. IMHO protecting small liquidity providers is not a strong reason. As I said before I think the exchange should be able to pay whoever it wants to. If they make a bad choice then volume goes elsewhere and they lose money, so it seems like they have the incentive to pick the right structure. And they are probably in a better position to pick the right structure than the government.

As for legislating who gets PFOF I think that is equivalent to restricting competition on commissions. We tried that for a while with stocks and decided it wasn't a good idea. Maybe it is a coindicidence but liquidity seems to have improved since commissions were deregulated.

 

[nitro]

Quote from black diamond:

Thanks for the reply. I understand, I just don't agree.

You might be right about what rules the exchange should choose but I don't think things like that should be mandated without a strong reason. IMHO protecting small liquidity providers is not a strong reason.

Actually it would protect everyone, not just the small liquidity providers. You think anyone likes paying PFOF whether they are a sole prop or SUSQ?

As I said before I think the exchange should be able to pay whoever it wants to.

Oh I agree completely. Too bad it is not the exchange that pays for order flow, it is the MM. The exchange just made the rule since it doesn't come out of their pocket, so why would they care?

If they make a bad choice then volume goes elsewhere and they lose money, so it seems like they have the incentive to pick the right structure. And they are probably in a better position to pick the right structure than the government.

In equities the Market TAKER pays for liquidity, why don't people run to other places to do their business where they don't have to pay for taking liquidity? BECAUSE the spreads are tighter on ARCA, NSDQ, etc. So as I stated on the post you are responding to, if you eliminate PFOF, or, you leave PFOF but you give it to the liquidiity providers the way that BOX has done, you will tighten spreads, and then volume will come to you. If no exchange was allowed to suck money from MMs to pay for order flow, then non of this nonsense would exist. It reminds me of being at a stadium watching a sporting event. If everyone sits down, everyone can see. As soon as the guy in front of me stands up,I am forced to stand up, causing a cascade of people to be forced to stand up. We all see perfectly well when we are all sitting down. Some idiot exchange (PHLX ?) invented PFOF as if this would create some sort of lasting edge to them. Didn't they think everyone would follow suit? What a bunch of morons.

As for legislating who gets PFOF I think that is equivalent to restricting competition on commissions. We tried that for a while with stocks and decided it wasn't a good idea. Maybe it is a coindicidence but liquidity seems to have improved since commissions were deregulated.

I have no problem with PFOF if only ONE thing changed: the PFOF goes to the final customer. Look, if I open an account with IB, or SCHAWB, or Ameritrade, or TOS, or 99% of the option brokers in this nation, and I buy or sell a put by hitting a bid or an offer, do I see the PFOF? NO!!!!! Why not? I am the market taker, no? This one rule change would now remove the incentive of the broker to steal from their customer.



How is that fair? To suggest otherwise is ridiculous. Instead what happens is the brokers and exchanges are in collusion with each other to route orders not to the best destination for the customer, but in order to suck the most profit from that order before it gets filled.

Nice.

 

[option911]

Ill concur all PFOF has done nothing but bad things for the market. Explain to me why pay for play is illegal everywhere but the option market???

http://www.option911.com

 

[black diamond]

Quote from nitro:

Too bad it is not the exchange that pays for order flow, it is the MM. The exchange just made the rule since it doesn't come out of their pocket, so why would they care?

Well you caught me here but I don't think this changes anything. They direct payment instead of paying it themselves. I think this is a little like arguing over who pays a sales tax, the buyer or the seller and the punchline is it doesn't matter who writes the check. In this case when a trade occurs they get to decide how to divvy up the value generated: keep some, give some to the liquidity provider, and some to the liquidity taker. So who cares if they are writing a check or just extracting less somewhere else?

Even if you don't buy this, they still should care because they will lose money if they lose volume from making a bad choice. Just like any other business making a price-volume tradeoff decision. I guess if you are a stickler for detail they don't lose money in the accounting sense but then make less than they would otherwise. I don't see how you can disagree that choosing the wrong structure will cost them money. Unless you really think there is no competition. Which I doubt, my impression is the exchanges and pseudo-exchanges generally want market share bad, but maybe you are right and they are all part of a secret cartel.

if you eliminate PFOF, or, you leave PFOF but you give it to the liquidiity providers the way that BOX has done, you will tighten spreads, and then volume will come to you.

Here I think you are probably right. Then BOX will make money. That is the incentive to make the right choice I have been talking about. But I think that is the exchange's decision to make, not the SEC's. If an exchange believes the opposite ( that spreads are wide because there is no volume, and a bit more order flow would attract limit orders and tighten spreads) they should be able to act accordingly.

How is that fair? To suggest otherwise is ridiculous.

That's not very nice. Your suggestions are EXTRA SUPER RIDICULOUS! It is not fair that you provide liquidity for a cost of more than 1 tick, you are stealing from the liquidity taker and trying to suck the most proft from every market order! That is the real outrage and where we should aim our regulatory efforts.

Seriously, I think it is fair that exchanges get to compete for trading volume on lots of dimensions. I also think it is fair that brokers (or most any business) try to charge what the market will bear. I think price controls have not worked well in the past in lots of different scenarios. I guess we'll have to agree to disagree on this one.

 

[nitro]

Quote from black diamond:
...

Ok, I am not explaining myself in a way that is being clear. Let me try a different approach. Let me try question/answer approach.

Q: Do you believe that PFOF as it exists now (without the recnt BOX change in strategy) helps customers get a better price than without PFOF?

Q: Or, if PFOF were allowed as it is now, but the PFOF is payed to the customer and not to the B/D, would this lower the cost to the customer?

Q: Or, if PFOF was payed by the market taker instead of the MM, would MMs then likely compete by streaming tighter spreads, since they have a revenue stream that they can lean on to compete for orders?

A: ?

 

[black diamond]

Quote from nitro:

Ok, I am not explaining myself in a way that is being clear. Let me try a different approach. Let me try question/answer approach.

Q: Do you believe that PFOF as it exists now (without the recnt BOX change in strategy) helps customers get a better price than without PFOF?

Q: Or, if PFOF were allowed as it is now, but the PFOF is payed to the customer and not to the B/D, would this lower the cost to the customer?

Q: Or, if PFOF was payed by the market taker instead of the MM, would MMs then likely compete by streaming tighter spreads, since they have a revenue stream that they can lean on to compete for orders?

A: ?

The short answer is I don't know. Without knowing much about this market I would guess the third one. But I can imagine scenarios where the other two would be better.

BTW this description sounds funny - I didn't think it is called PFOF when the MM gets paid a rebate. Is that correct? I thought historically PFOF evolved from the MM paying for good orders not likely to be informed, IOW PFOF is the liquidity provider buying market orders. So now there is payment for order flow made by (not to) the one who is directing the order flow?

But more importantly my point is not that you are wrong about which design is better, but that I disagree with the idea of someone other than the exchange choosing a one size fits all design and imposing it.

 

[option911]

I can tell you that as a former mm PFOF has driven away independent market makers, put all of the order flow in very few hands, encouraged internalization of order flow, limited innovation, and artificially kept several exchanges open (I’m talking to you PSE AND PHLX)! There are other problems as well; it causes 'smart routers' to route to illiquid exchanges. It encourages your broker not to teach you about trading the big indexes vs. the etf's. The list goes on and on. This process has been good for the Option Expresses (Express's?), and TOS's, and that is about it. If the regulatory bodies understood the option markets (they don’t), this type of practice would be as illegal as any other kind of bribe.

http://www.option911.com

 

[nitro]

I mean to respond. I have a head cold.