Intermarket sweep orders (ISOs) are giving some options exchanges a black eye.
The order types, which only went into effect last summer, have caused the execution statistics of some options exchanges to look bad.
"These ISO order types are not being accounted for in the best execution stats," Alan Grigoletto, senior vice president of business development and marketing at the Boston Options Exchange, told Traders Magazine. "They make it look like you executed an order worse than at the NBBO."
The problem starts when an exchange executes an ISO at a price inferior to the NBBO. Normally, that would be considered "trading through" the NBBO, and is not allowed. But if the trade involves an ISO, an exception is made. That’s because a companion ISO has been sent to a second exchange which is displaying the NBBO. A trade occurs at the NBBO, negating the trade-through at the first exchange.
Although the trade-through is permitted under Securities and Exchange Commission rules, it is still a trade at a price inferior to the NBBO. As such, it could mar the execution quality statistics that exchanges have agreed to publish on their Web sites every month.
The rules governing dissemination of the statistics were devised by SIFMA’s options committee in 2008, and are similar to the SEC Rule 605 statistics required of exchanges and brokerages in the cash equities business.
In 2008, SIFMA made no provision for ISO orders, as they were not yet in use. Some exchanges such as BOX include the ISO trade-throughs in their monthly report, others such as the International Securities Exchange don’t.
Grigoletto wants SIFMA to address the issue. "They have to make clear how we are going to account for it," the exec said. "They have to make sure the files get correctly adjusted for any ISO types."
One source knowledgeable about the SIFMA rules said the options committee told the exchanges not to include the ISO orders in their reports.
In any event, SIFMA is working on a second version of its reporting regime and plans to address the issue. "We are taking another look at the best execution statistics," Joanna Fields, a Deutsche Bank executive and head of the SIFMA options committee, said at a recent industry conference. "ISO sweeps are definitely going to be part of our review."
