Two changes are afoot in the options world. One will impact all options traders. One may have little impact.
In a May 9 article titled "Are OPRA-Designated Options Symbols Disappearing?", I wrote about OPRA codes for options and some of their benefits and drawbacks. OPRA stands for "Options Price Reporting Authority." The term "OPRA codes" references a convention that explains why an IBM NOV 100 call might have the code name IBMKT. For more background information, you can find that article here in the archives.
That article included a link to the "Symbology Initiative." The initiative had been in place since July 2005, when the Board of Directors of the Options Clearing Corporation asked the staff to start working toward an eventual elimination of the OPRA codes. Now the Options Clearing Corporation wants you to "Get Ready for the Options Symbology Initiative," setting up FAQs for you to check at this link.
The OIC wants you to get ready because OPRA codes will go the way of other trading dinosaurs such as options quoted in eighths no later than February 12, 2010. The OIC adds that "symbol consolidation from the existing options root symbol (e.g., MSQ) to the underlying symbol (e.g., MSFT) will be complete in May 2010." The OIC assures readers of a one-page fact sheet that current options positions will not be impacted. Exchanges, broker-dealers and vendors are all busy implementing the changes.
Options will be identified by four bits of information: options symbol, which will usually be the same as the symbol of the underlying; expiration date; expiration price; and call/put indicator. If you read my original article, you know that the change doesn't appear to be any shorter or easier to type into an order form, if your online brokerage still requires you do so. It conveys information in a longer format, but that information does seem more easily understood.
That's not the only change afoot in the options world, however. Last week, I wrote about flash trading, an article I wanted to submit before including information about another change that has already been implemented: Distributive Linkage.
When I first read about the August 31 rollout of the "Distributive Linkage" that recently went into effect across all seven options exchanges, I thought the information might not apply to us retail traders. Peppered through the available literature on the subject are references to "large" orders along with technical information about crossed and locked markets. Information sheets seemed to have been prepared with the market maker in mind. Examples included 5000-lot trades. When I wrote the contact person listed on press releases about the change, I never received a reply. A former market maker confirmed that the change would probably have little impact on the retail trader.
The "distributive" in that name references the way that orders are handled. If I've understood the concept correctly, when an exchange can't fill all the order at NBBO, it can distribute the order itself rather than routing it to a central hub to be distributed.
However, let's talk a little about what the change will do. You should perhaps first know that the reason that the topic caught my eye was the following sentence: "There is NO depth-of-book protection, only top-of-the-book protection," referencing large orders.
To explain what will happen with those large orders, I'll need to borrow a graphic from SIFMA's explanatory paper on the new change.
Bids on Four Exchanges, from SIFMA Paper:
Suppose an order to sell 5000 is sent out and lands at Exchange D, the SIFMA paper proposes. Obviously, someone selling wants the best price possible, the NBBO. Obviously, Exchange D with its $0.47 bid does not offer that NBBO. Under the Distributive linkage program, however, Exchange D can send an Intermarket Sweep Order (ISO), a type of limit order, to Exchange A for 700, to Exchange B for 900 and Exchange C for 300 and then can fill the rest, 3,100, for its $0.47 bid. This is true although once Exchange A's top-of-the-book block of 700 is taken out for $0.52, the next bid for 100 shares is still a better offer than Exchange D's $0.47. In fact, the market-depth figures shown here reveal that there were currently 760 more bids for higher than Exchange D's top-of-the-book $0.47 bid.
This results in large trades that "might fill against quotes priced worse than the market's best bid or offer (NBBO)," SIFMA says, but "only after they [the exchanges] have met the requirement to sweep the top of the book for eligible protected markets." This includes customer orders resting on the books.
This isn't flash trading, of course, but I was researching both at the same time. Perhaps that's why that "worse than NBBO" comment struck me so strongly. I wondered if some the same pro-and-con arguments made about flash trading could be made about this change, too.
SIFMA suggests that each exchange's rules be consulted for further information. When I followed the link to the NYSE's page on the new program, I found that the NYSE Amex stated that "orders sent to NYSE Amex always receive the best possible execution because, if we are not at the NBBO, we immediately route to the away markets with the best price. There will be no deterioration in best execution on NYSE Amex." The Nasdaq Options Market (NOM), however, warns, "Orders marked as ISO bypass the system rules that only allow executions at NBBO or better." An ISE document provides many examples of specific trades and how they might be routed, if you're interested in investigating further.
For now, it looks as if our retail trades are likely to be filled at NBBO and not get those disadvantageous fills with the "top of the book" protection not offered. We're usually grousing about the cons of being a retail trader, but, maybe, in this one case, it's a good thing to be a retail trader who likely won't suffer any ill effects.