The adoption of a new pricing model by the C2 Options Exchange appears to be bearing fruit.
Last week, C2, one of two options exchanges operated by CBOE Holdings, saw its market share grow to more than 2 percent–its highest level ever-in the wake of price changes meant to encourage inbound retail flow.
Under changes that went into effect on February 1, C2 dropped its maker-taker pricing model for taker-maker. Now, C2 pays retail, or “priority,” customers who take liquidity and charges those market participants who supply liquidity. Previously, all liquidity takers paid and all liquidity providers received a rebate.
(The new rebate only applies to retail customers that remove liquidity. All other liquidity-takers still pay a fee when they take liquidity.)
According to data provided by the Options Clearing Corporation, C2 traded about 2.34 percent of the total number of stock-linked contracts traded last week. That compares with a share of 1.69 percent for all of February, and 1.36 percent in March 2012.
Breaking through the 2 percent barrier represents a milestone for the C2, which has struggled to garner flow since it was launched three years ago. The pricing changes follow the exchange operator’s decision to transfer a contract based on the S&P 500 Index over to sister exchange Chicago Board Options Exchange due to a lack of business.
Ed Tilly, CBOE president and chief operating officer, told reporters in January that with the transfer of the SPXpm contract, the company was free to experiment with different pricing on C2. “So now what happens to C2,” he asked. “Without its premier contract we are still left with an alternative venue to test alternative pricing models and different algorithms. A half percent market share is not where we want C2 to be. So, we will change the pricing.”
In terms of market share, the exchange is now operating on a par with the much older BOX Options Exchange.
For C2, the surge occurred after the exchange made a radical change to its pricing model. Before February 1, C2 paid market makers and others for supplying liquidity, while charging public customers and others for removing it. That is the conventional maker-taker pricing scheme.
Under its new taker-maker pricing model, market makers will pay to supply liquidity while retail customers will receive a rebate for taking it.
The model is similar to the one used by BOX and a few stock exchanges. It encourages retail brokers to direct their flow to those exchanges as their customers are predominantly price-takers.
As part of the change, C2’s per-contract fees and rebates are not flat. They are determined by a formula that is dependent on the bid-ask spread of the option, the trader’s status, and the size of the order.
The charge for supplying liquidity, for example, is equal to the product of an option’s bid-ask spread, a pre-set “market participant rate,” and a multiplier of 50. So, if the spread is 3 cents and the MPR is 30 percent, for example, then the fee would be 45 cents per contract.
The rebate for taking liquidity is equal to the product of an option’s bid-ask spread, a pre-set “order size multiplier,” and another multiplier of 50. If the spread is 3 cents and the order size multiplier is 30 percent, then the rebate would be 45 cents.
In the options industry, market makers supply most of the liquidity and public customers take most of it.
Under C2’s old pricing model, market makers received a rebate of 25 cents per contract. Under the new model, they may pay as much as 85 cents-the maximum-to supply it. The rate depends on the bid-ask spread. As dealers are assigned a market participant rate of 30 percent, an option with a three-cent spread would translate into a $0.45 fee. Any spread in excess of six cents triggers the fee cap.
In a filing with the Securities and Exchange Commission, the C2 noted that it tied the fee to spread widths in order to encourage dealers to quote tight markets. The spread between the market’s best bid or offer is “an important component of market quality and of the cost of using an exchange market,” C2 told the SEC.
On the take side, under the C2’s old pricing model, public customers paid $0.25 per contract to remove liquidity. Under the new model, they may receive as much as $0.75-the maximum-to remove liquidity. The amount depends on both the spread and the size of the order. The narrower the spread and the smaller the order, the more the customer receives.
If an option’s spread is three cents, for example, a public customer would receive a $0.45 rebate if he was trading between 11 and 99 shares, for instance. That many shares equates to a 30 percent multiplier.
The C2 tied the rebate to the size of the order because it “desires to attract smaller orders,” it told the SEC in the filing, adding “smaller orders are more attractive to market makers because they are easier to hedge than large orders.”
The new pricing only applies to single legged stock options trades and does not apply to trades of options on indexes or exchange-traded funds.
