Nasdaq OMX Group’s BX Options exchange will start to differentiate itself from its older sister, the Nasdaq Options Market, by favoring size over speed on contracts involving two stocks and one ETF.
BX will alter its order allocation formula on Thursday from a method that favors the fastest traders to one that favors the largest, according to a Nasdaq notice to members.
Currently, incoming orders for all options are divvied up amongst liquidity providers on a first-come, first-serve basis. This benefits those suppliers that get to the front of the queue the fastest.
Beginning Thursday, orders in three option contracts—those involving options on the movement of the stocks of Bank of America Corp. and Research in Motion, Ltd., and one on the Invesco PowerShares QQQ Trust, an exchange-traded fund—will be allocated to liquidity providers on a pro-rata basis, in proportion to the number of contracts displayed in their quotes, according to the memo. That will benefit those traders displaying the largest size.
Most liquidity on options exchanges is provided by market makers. Under the Nasdaq BX scheme, customer quotes will have priority over those of market makers, but customer quotes are considerably fewer in number.
Besides BAC, QQQ, and RIMM, all other options will trade on a first-come, first-serve, or price/time, basis, according to Nasdaq.
The pro-rata methodology has been the norm in the options industry for years. It is currently used by the older, dealer-dominated exchanges such as NYSE Amex, International Securities Exchange, Chicago Board Options Exchange, Nasdaq OMX PHLX, and the BOX Options Exchange.
The scheme contrasts with the price/time priority methodology used by the newer options exchanges such as NOM, NYSE Arca, and BATS.
When Nasdaq launched BX Options in June, it adopted the structure of NOM for the sake of expediency. However, in its public statements, Nasdaq stated it would change the allocation methodology before the end of the year for certain options contracts.
Because BX Options also offers non-standard taker-maker pricing, it has been compared to the BOX options exchange, operated by the TMX Group and seven broker dealers . That exchange has long used taker-maker pricing in combination with pro-rata allocation.
Taker-maker rewards brokers that take liquidity with a rebate while charging a fee to those that provide it. The pricing scheme is non-conventional as most exchanges that use rebates, dole them out to liquidity providers. The pro-rata allocation methodology used by BOX and, now, BX Options, softens the blow for those who provide liquidity in size.
Nasdaq plans to change over more options to pro-rata trading, but declined to offer details.
