December 2006
Monthly Archive
Death to Payment for Order Flow.
Posted by wenzi on 29 Dec 2006 | Tagged as: (t)
I have had a personal problem with payment for order flow ( payment for order flow ) for a long time. In Jan 2007, the SEC will have a trial for options priced in pennies. A penny option is an option that has a price increment that can move 0.01. Most options now trade with increments of 0.05 and 0.10. So say an option is trading at 1.05/1.10 bid/ask. The dealer makes the 0.05 ( $5 ) spread between the bid & ask. With penny priced options you COULD have a spread of 1.05/1.06. Not as much room to make money off the spread. Of course, some options will have a wider spread.
The move to penny options will give investors a better price. It will cut down on the amount dealers can make from the spread, and thus how much they can pay for order flow. This also hurts internalization ( internalization ) , but brokers continue to do that after equities went to pennies, so I cannot see it stopping with options.
I feel a broker has a duty for best execution, and payment for order flow is a conflict of interest. I think their are other ways of getting order flow besides payment for order flow. Subsidies, co marketing arrangements, and the like are ways that other markets increase order flow, and it should be the same with securities firms.
Here is a paper from 2001 by Allen Ferrell on payment for order flow. A good read if you have the time.
| Steve Sanders of Interactive Brokers, said it best when he said that the move from nickel to option penny pricing is inevitable and if exchanges can’t handle the volume, then the business will switch to competitors. |
The SEC’s pilot on penny options pricing is scheduled to begin on Jan. 27. 2007.