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The BOX Rebellion

A proposal by the Boston Stock Exchange to launch the Boston Options Exchange - known as The BOX - is stirring up the industry as it awaits regulatory approval from the Securities and Exchange Commission.

A proposal by the Boston Stock Exchange to launch the Boston Options Exchange - known as The BOX - is stirring up the industry as it awaits regulatory approval from the Securities and Exchange Commission.

The BOX is an automated-trading facility for standard equity options under the regulatory auspices of the Boston Stock Exchange (BSE), one of its founders, along with Bourse de Montreal and Interactive Brokers Group, LLC.

Four securities firms - Credit Suisse First Boston, J.P. Morgan, Salomon Smith Barney and UBS (USA) Inc. - have become investing partners in Boston Options Exchange Group, LLC.

"While the ISE (International Securities Exchange) proposal was fairly disruptive when it came out, this is like a cannon going off compared to the ISE's shotgun," says Christopher Nagy, head of trading at Omaha, Neb.-based Ameritrade.

As a sign of the controversy, the original BOX proposal - which has been revised more than once - has generated 32 comment letters from a range of market participants, including market makers, who mostly oppose it because, they contend, it threatens their livelihood.

"If I were a market maker on the floor, I'd be concerned about the BOX," says Nagy.

Officials with The BOX declined to comment for this story.

According to a BSE spokesperson, the BOX is in a quiet period because it's waiting for SEC approval.

Some industry participants say the new exchange may open a Pandora's box as it plans to offer price improvement by a penny and internalization of orders, which could impact price transparency.

In a comment letter, Chicago Board Options Exchange (CBOE) President William Brodsky, states, "It proposes nothing more than an internalization mechanism in which order-providing firms will be able to avoid exposing their customer orders to meaningful price discovery in a manner completely contrary to the notion of an exchange-auction market."

Floor-based exchanges have already faced competition from the ISE, the nation's first electronic-options exchange which is now the largest equity-options exchange.

"They're not the first to do this," says Sang Lee, manager of the securities and investment practice at Celent Communications. "Even in the automated-exchange model, they're second to market behind the ISE. I don't think that a miracle can happen twice," says Lee, referring to the ISE's success in siphoning market share away from the CBOE and the American Stock Exchange.

According to Nagy, the BOX is no clone of the ISE. The BOX has some unique features related to internalization of order flow through a mini-electronic auction it calls Price Improvement Period (PIP).

With internalization, market makers and other order-flow providers could match or cross orders by providing price improvement over the NBBO (national best bid or offer), without exposing the orders to the price-discovery process visible to the public.

"It will allow any order-entry firm or market maker to internalize 100 percent of their order flow," says Nagy.

But Nagy says the most controversial piece is that PIP will allow for penny price improvement. "That's very important because the options exchanges trade in nickels and dimes," explains Nagy. Right now, the minimum quoted spread is either a nickel if the options quote is at or below $3 and it's a dime if it's above $3, he says. The BOX would bring the price-improvement increment down to a penny. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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