A tsunami of ever-speedier quote traffic is swamping options exchanges, leading the Securities and Exchange Commission to take steps toward reining in increasingly aggressive high-frequency traders.
The federal intervention is aimed at slowing an explosion in data across the Chicago Board Options Exchange and other U.S. options platforms that some traders and vendors say is handicapping conventional market participants. They complain that the crush of orders and cancellations, flowing at a rate as high as 8.5 million a second, is overwhelming computer systems, distorting price information and thrusting them into a high-tech arms race they can't afford.
The SEC, already scrutinizing ultrahigh-speed trading following last year's flash crash, is primed for action if the exchanges don't take its suggestions and act first.
“One of the issues we're reviewing is whether the exchanges should impose a charge for excessive order messages, or for message traffic generally, in order to meet their statutory obligation to equitably allocate fees,” said David Shillman, the SEC's associate director of trading and markets.
MAKE EVERYONE PAY
Traders and vendors contend that the SEC also could reduce the blinding data flow by charging all traders, including market makers, to pay the same rates for quote cancellations as less active traders do now. They also advocate putting time stamps on quotes and requiring that prices be displayed for a longer, set period of time so there's a higher chance of executing against it.
David Fisher, chief executive of The Charles Schwab Corp.'s OptionsXpress retail trading service, said exchanges have had informal discussions about new standards. Mr. Fisher, who was a director at the Chicago exchange's parent, CBOE Holdings Inc., until two weeks ago, declined to provide details, though the CBOE acknowledges discussions.
“It's ridiculous,” said Mr. Fisher, citing one day last month when there were 6 million messages per second, up from 45,000 messages per second on average in 2004.
Without action, the cost of higher-speed technology could sap liquidity in the market by driving out smaller traders. Too much regulation, however, could thwart the beneficial liquidity and tighter spreads provided by the high-frequency traders.
Edward Boyle, managing director of high-speed-trading firm Getco LLC, argued at an industry conference this month that market makers have improved the options market by narrowing the spread between buy and sell quotes.
The increase in electronic messaging has been sudden and extreme. Over the past year, such chatter has increased 21/2 times, while actual trading volume has risen roughly 22%. Option Price Reporting Authority LLC, which distributes data from all the exchanges, estimates that traffic will jump another 58% by 2013, to 10.38 million messages a second.
The SEC also is concerned about rising quote traffic in the stock market, but the increase is much heavier in the options market because of the plethora of pricing variables, including the strike price, expiration date and put/call difference.
To keep up, some traders and retail-trading service providers said that they are being forced to invest in ever-more-powerful telecom lines and computer equipment to absorb unneeded and quickly outdated quote data created by the faster rivals.
“My costs are going up,” said Harold Lanier, an independent trader, whose telecom expense has doubled in the past two years despite a move to the less expensive town of Fairhope, Ala., from Atlanta. “The data quality is going down.”
He and other traders, including mutual fund managers who trade large orders, said quote cancellations and price moves increasingly render their offers obsolete before they can respond.
“The market is extremely difficult in terms of getting orders filled,” said Benjamin Londergan, who leads the options market-making firm Group One Trading LP and also is a CBOE director.
Executives from the CBOE, the biggest options exchange, and the No. 3, the International Securities Exchange, as well as the Options Price Reporting Authority, said the upsurge isn't overloading their capacity or hurting price transparency.
DATA FLOW CLOGS
But Nanex LLC, which compresses data from OPRA and sells it to traders such as Mr. Lanier and brokerages, regularly spots data flow clogs that result in outdated prices, according to founder Eric Hunsader.
For instance, on Aug. 10 at about 9:50 a.m., 8,557 quotes for 522 Baidu Inc. options in one millisecond (the equivalent of 8.5 million quotes in a second) overloaded one of OPRA's 48 communication lines and crashed it for 60 milliseconds, with another 40 milliseconds recovery that included spitting out old quotes, Mr. Hunsader said.
This year, he upgraded to a 10-gigabit circuit, from a one-gigabit, escalating his data line bill to $40,000 a month, an eightfold increase. He is considering ending his options service as a result.
Lynne Marek is a senior reporter at sister publication Crain's Chicago Business.