Morgan Stanley & Co. Incorporated
January 6, 2003
Jonathan G. Katz
Re: File Number SR-PCX-2002-36
Dear Mr. Katz:
Morgan Stanley & Co. Incorporated welcomes this opportunity to comment on the Pacific Exchange's proposal to implement a new trading platform for the trading of listed options, called PCX Plus. In general, PCX's proposal would (i) allow member firms to act as market makers from off the trading floor, combining its current floor-based trading model with remote market making into one consolidated book (and thus allowing broker-dealer and market maker orders, as well as customer orders, on the book) and (ii) provide for new order handling procedures regarding priority and the execution of orders.
Morgan Stanley generally supports market initiatives that will improve competition and transparency in the U.S. options markets, and the quality of those markets, not only on our own behalf as an active member of those markets but on behalf of our many customers (both retail and institutional) who transact in listed options. As discussed in more detail below, one of the most important changes we feel is necessary in the options markets is open access to all market participants. We strongly believe that allowing a greater number and different types of market participants to access the options markets on a level playing field will enhance competition and provide for greater transparency in the marketplace. Increased competition between and among market centers, especially when combined with competition for order flow based on price (for instance, by providing incentives for aggressive quoting), will lead to tighter spreads and more liquid markets, which should improve the quality of executions available to the investing public.
We support PCX's proposal as an advancement over a purely floor-based model for the trading of listed options because we believe the proposal will lead to increased competition and transparency. Many market participants that have not traditionally been market makers (such as ourselves) are ready and willing, and have the ability and desire, to improve the quality of the options markets by providing a greater amount of capital and liquidity to those markets. By allowing for remote market making from off the floor of the exchange, PCX's proposal will enable additional market participants to interact more directly in the price discovery process and will allow those firms that are highly capitalized to support the prices they project to the market with substantially more liquidity than currently exists on the PCX.
In addition, PCX's proposal would reward market participants for aggressive quoting, in part by granting participation rights to market participants who quote first at the best price and by allocating among market participants quoting at the same price on a "size pro rata" basis. While we support these provisions as a step in the right direction, we continue to believe that even greater incentives to quote aggressively would result from pure price/time priority, ultimately leading to more price competition, tigher spreads and improved executions.
We also support PCX's proposal because it will bring more efficiency to the listed options markets by providing another electronic means of trading listed options. We believe that electronic trading can and does provide for greater efficiency and economies of scale and that market participants, most notably public customers, will benefit from more efficient markets. For instance, electronic markets allow for lower administrative costs, such as the costs of providing for floor personnel and operations. They also provide for less "friction" in the system, through faster executions and less human, subjective intervention. As trading and other technology continues to develop at a rapid pace, customers and other market participants in the U.S. securities markets in general, and the listed options markets in particular, have a greater need for, and are demanding, more efficient electronic access to the market. For instance, we note the success of the International Securities Exchange, the only fully electronic marketplace for the trading of listed options in the United States, since it opened for business roughly 2 1/2 years ago. We believe that PCX's proposal will provide additional efficiency in the listed options markets.
While we view PCX's proposal as an incremental improvement over the status quo, we believe that the U.S. options markets must be allowed to evolve further, to a point where there is truly open access and where "non-conventional" market structures are given the opportunity to flourish. Allowing for the electronic trading of options in what is essentially still an auction-based market is a step in the right direction, but should serve only as an interim step to allowing truly "alternative" markets for options trading. While we recognize the Commission's apparent desire to resolve certain fundamental structural issues in the trading of listed options (such as dissemination of a consolidated national best bid and offer, a permanent linkage and standardized execution quality data) before addressing the broader issues of open access and alternative market structures, we strongly believe that it is imperative to continually move forward to resolve these issues, and urge the Commission to work expeditiously with the options exchanges to implement these basic but essential changes.1
We thank the Commission for this opportunity to comment on PCX's PCX Plus proposal, and urge the Commission to approve the proposal. Please feel free to contact me at (212) 762-8193 or Heather Seidel at (212) 762-7832 if you have any questions or would like discuss our comments.
cc: The Honorable Harvey L. Pitt, Chairman