Electronic Equity Options Trading: A Technology Transformation for a New Market Structure

September 23, 2008


Boston, MA, USA September 23, 2008

The listed equity options markets are entering a demanding and challenging phase, with 2007 contract volume growth at 41%, penny pricing implementations, new maker-taker models, and greater institutional buy side interest. Lower latency trading and enhanced matching and order routing systems at exchanges, along with customized algorithms and multi-asset trading, will significantly alter the landscape between 2008 and 2012.

Liquidity, book depth, latency, and price improvement will come into greater focus as the US equity options market structure changes in the next few years. Already, new pricing and market models have been rolled out, including the maker-taker model, an equities market import. Electronification, once rare on the crowded options exchange floors, is now the dominant method of execution, although open outcry volumes are still estimated to be 29% of overall listed options volumes.

In a new report, , Celent predicts that electronification rates of US exchange-traded options will reach 85% of overall volumes in 2012 from 71% in 2008, as more institutional block and complex orders move to automation.

Listed equity options contract volumes are projected to grow at a rapid CAGR of 25% until 2012, due to increasing traditional investment manager interest, growing buy side utilization of option algorithms, the benefits of portfolio margining, and decimalization. Greater messaging volumes, quotes, and option strikes will mandate technological enhancements from all market participants, including brokers, exchanges, specialists, market makers, and the buy side.

"Options markets are still comparatively fragmented in liquidity and see a greater volume of messaging and quote updates than cash equities. With a market structure which effectively only allows trades to be executed on exchanges, systems enhancements have been historically concentrated on these exchanges," says David Easthope, senior analyst with Celent's Capital Markets group and coauthor of the report. "Technological responses to the trading arms race will be widespread and come in the form of direct market access (DMA), multiasset trading capabilities, algorithmic trading, hardware and software upgrades, and colocation offerings.

Moreover, consolidation and convergence will be key trends in the industry as less adept players are sidelined in an increasingly tougher technological game. "Seven independent exchanges have now been reduced to five, but market practice and uncertainty have kept the old models alongside the new for now," says Chermaine Lee, analyst with Celent's Capital Markets group and coauthor of the report.

To date, exchange platform technologies have been consolidated in parallel both between and within exchanges. Going forward, competition in the lucrative options sphere will force more technology transformations in order to satisfy a broader and growing investor class appetite for this asset class that was once untouched and sometimes considered too risky. Technology will be a clear differentiator for participants who seek to stay ahead in the shifting equity options market terrain.

This 60-page report contains 23 figures and 13 tables. A table of contents is available online.

Members of Celent's Capital Markets research service can download the report electronically by clicking on the icon to the left.  Non-members should contact info@celent.com for more information.


Celent is a research and advisory firm dedicated to helping financial institutions formulate comprehensive business and technology strategies. Celent publishes reports identifying trends and best practices in financial services technology and conducts consulting engagements for financial institutions looking to use technology to enhance existing business processes or launch new business strategies. With a team of internationally based analysts, Celent is uniquely positioned to offer strategic advice and market insights on a global basis. Celent is a member of the Oliver Wyman Group, which is a wholly-owned operating unit of Marsh & McLennan Companies [NYSE: MMC].

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Table of Contents

Boston, MA, USA September 23, 2008

Executive Summary 3
Introduction 5
Listed Options Market Landscape 7
Options Exchange Operational and Market Models 14
OTC Options Market Landscape 20
Options Market Drivers 23
  Rise of Multiple-Listed Products 23
  Electronic Evolution of Equity Options Trading 24
  Expansion of Asset Class / Adoption of Options Trading Strategies 25
  Contract Volume 29
  Message Volume 30
  Direct Market Access (DMA) in Derivatives 32
Options Market Evolution 34
  Consolidation of Exchanges 34
  Trends in Market Share 35
  New Infrastructure, Models, and Players 38
  Non-Displayed or Dark Orders--The Hidden Pennies 38
  Options Dark Pools 39
  Proprietary Products 41
  New Pricing Models and Structure 43
Options Market Outlook 47
  Fragmentation 47
  Volumes and Value-Traded 48
Changing Systems Requirements 49
  Market Evolution Forces Change 49
  Exchanges 50
  Brokerage Firms and Market Makers 51
  Buy Side 52
  Technology System Vendors 52
Changing Systems Requirements 53
  Market Evolution Forces Change 53
  Exchanges 53
Conclusion 58


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