A recently approved options order–a type of block trade called the Qualified Contingent Cross (QCC)–is challenging the status quo of the listed options markets. It’s also raising questions about the future role of options exchanges.
The QCC owes its creation, in large part, to the International Securities Exchange (ISE), which got final SEC approval for QCCs this past February. In March, NYSE Euronext, an ISE competitor and former foe of QCCs, asked regulators to allow the NYSE Arca and NYSE Amex options markets to also offer QCCs.
QCC orders are multi-leg trades that involve both an option and a stock component. For the option leg of the order, the minimum size is 1,000 option contracts and the execution price must be at or better than the option’s National Best Bid or Offer (NBBO). The QCC option piece cannot trade in front of a customer order though. The stock component requires that a minimum of 10,000 shares be executed–however, these shares can be executed in a dark market and outside of the NBBO. Institutional brokers can now essentially cross these QCC orders electronically without exposing them to the broader market, thereby bypassing the full competition of open exchange markets.
Over the past two years, and even today, critics say QCC orders represent "de facto internalization" and threaten the way the options markets work because they sidestep market exposure and indirectly bypass customer priority. Market makers who object to QCCs say that large institutions are using the order type to trade size and sidestep intermediation. The major players are likely to argue that they prefer the ability to get size done through QCC orders–without the concern of a large order being broken up, only partially executed and still yet fully displayed to the larger market.
Interestingly, any move towards wider acceptance of options dark pools mirrors the fundamental transformation that we saw in the equities marketplace several years ago when dark pools and alternative trading venues first took hold. Similar to the equity space, options dark pools could very well gain traction as large options players seek tailored venues for their large orders that would otherwise set off disruptions in other markets. There have been prior attempts to establish entities resembling an options dark pool (Ballista and 3D Markets come to mind) but they did not gain widespread traction. This may be another case where options markets follow their equity brethren with respect to both structure and behavior.
As we enter mid-2011, it appears that institutional options players fully drive the U.S. options markets now. A study released by the Options Clearing Corp. last fall found that orders with one to 10 contracts comprise 77 percent of all orders sent to the options exchanges but only 17 percent of total volume. Orders larger than 500 contracts represented only 0.2 percent of orders but constituted 20% of total volume! For all intents and purposes, size is now driving options markets, and the days of the smaller trading options market-maker, or "local" are drawing to a close.
Given these conditions, could QCCs be the start of a major overhaul? Could QCCs revamp the role of the options exchange in the coming years if more orders are being matched upstairs? It might happen if a majority of buyers and sellers match their transactions away from the established venues. In that scenario, options exchange floors become no more than glorified pricing mechanisms for QCC orders. We will all stay tuned as the options landscape continues to shift.
Russ Chrusciel is a product manager, derivatives, at SunGard Global Trading.
The views represented in this commentary are those of its author and do not reflect the opinion of Traders Magazine or its staff. Traders Magazine welcomes reader feedback on this column and on all issues relevant to the institutional trading community. Please send your comments to Traderseditorial@sourcemedia.com
