"The technical cost of managing and distributing the tremendous amounts of market data being generated… can no longer be taken as a given,” said Richard Gissing, managing director of UK-based market data software vendor Mighter Gissing. “Both the vendors and the market players are undertaking very serious cost/benefit analyses on the distribution of equity derivatives market data to their global client base."
One of the main causes of concern is the burgeoning equity derivatives market, where market makers generate prices to exchanges based on movements in the market, and also on movements in the underlying equities. "Equity derivatives have definitely been one of the main drivers behind the growth in contributed data volumes during 2002," said Gissing.
Industry participants have to accommodate large numbers of derivatives instruments, listed on multiple exchanges. "If Microsoft stock moves, [as many as] 500 options have to update," said Andrew Murphy, a London-based senior consultant at PA Consulting. "It’s a big problem limited to a small number of US equity options exchanges," he said, citing the Chicago Board Options Exchange (CBOE), the Philadelphia Stock Exchange, Amex, the Pacific Exchange and the International Securities Exchange (ISE). Due to the sheer number of option instruments, these five generate half of all data carried by US vendors, he added.
A spokesperson for ISE paints the exchanges as victims of their own success. "We try to be as prudent as possible with our quoting," said an ISE spokesperson. "We would support reforms to address the capacity issues and implement quote mitigation solutions. But information is being generated, the market needs information… and the market always finds a balance sooner or later," the spokesperson said, adding that the exchanges and the Options Price Reporting Association (Opra) have done their part by already expanding capacities in recent years to cope with the derivatives growth.
Also to blame is the decimalisation of the US equity markets. Before the conversion to decimals in 2001, the smallest price change possible was one-sixteenth of a dollar. Now, users are able to trade every cent, which gives more potential equity price changes, and therefore more changes in options prices, said Murphy.
A full version of this story is available at the home page of RiskNews’ sister publication Trading Technology Week.