March 4, 2008
The International Securities Exchange's (ISE) proposed rule change is nothing short of laughable. At is core the rule suggests that any person who wishes to consider themselves a retail customer forgo any type of trading technology, which of course is widely available in today's market, and wander into the marketplace blind and helpless. With the ISE's battery of ridiculous trading regulations that limit the number of orders a customer can generate and cancel, a retail customer is left to ask what more "advantage" could they possible give up, and to whom.
One must ask how the number of orders entered could possible be a proxy for that investor's level of sophistication. Maybe the ISE could come up with a formula that designates customers by number of orders generated that are close to an option's theoretical value, and those traders could be placed in another category of, say "informed investors", with the requisite restrictions for their "advantage". How about a category for public customers that enter orders that are too large, the ISE could classify them as "Big Customer" and limit the size or add additional fees to their orders. My point, of course, is that the exchange's arbitrary classification of public customers and the rules that govern their trading is inherently flawed, and serve no other purpose than to limit competition to the ISE's specialists. If the SEC allows the ISE to reclassify their customers in any manner they see fit, they would open the door to all exchanges to custom tailor who gets to trade and who is effectively shut out of the market.
Broker dealers and market makers continue to erode the "priority" of the public customer in the name of fairness, yet an analysis of who benefits from the rule changes always finds the specialist benefit through reduced competition. Broker dealers and market makers enjoy many advantages over retail customers, namely; the ability to stream quotes for multiple options series, favorable margin treatment, the ability to quote options on both sides of the market, and the lack of a cancellation fee. The price of those advantages is an exchange fee, and lower priority. A retail customer has a battery of restrictive regulations to abide by, additional fees if they are too price sensitive, and substantially higher margin requirements. The only customer advantage is priority. The conclusion of this analysis begs the question, “How does the unsophisticated investor gain an advantage when a market participant is severely limited in their market participation, and what are the unintended consequences?” The answer is, of course, the multi-advantaged specialist can set market prices with little or no competition from retail customers.
I further urge the SEC to review the option exchange’s rules regarding cancellation fees, and other exchange regulations that limit the public’s participation in the price discover process. I would appreciate an explanation on how these rules have increased market depth and liquidity, and tightened bid/ask spreads.
The SEC has a chance to rein in the ISE and other options exchanges that have made it a habit over recent years to put the exchange’s interest in front of those of the open and fair market. The ills of the exchange and its member specialists should not be solved by restricting public customers, but by modifying the exchange’s business model to adapt to the new financial landscape.