Friday, March 9, 2007
The Commission’s staff today released a report summarizing the results of recent examinations and analysis of routing and execution practices in equity options. The “Report Concerning Examinations of Options Order Routing and Execution” can be found on the Commission’s website. The SEC’s Office of Compliance Inspections and Examinations, with the staff from the Division of Market Regulation, conducted a series of examinations of the options order routing practices of eight broker-dealers that have a significant amount of retail options order flow. In addition, the Office of Economic Analysis conducted an analysis of quote competition among the options markets. Today's staff report describes broker-dealers’ current order routing practices, including the use of “smart routing” technology, opportunities for price improvement for retail options orders, and payment for order flow and internalization practices. Among other things, the staff found the following.
Many firms have begun to utilize order routing technology — often called “smart routers” — to ensure that marketable retail customer options orders are sent to the market displaying the best price.
While there has been improvement in order routing firms’ processes to seek and obtain best execution for their retail customers’ options orders, multiple market centers often display the same best price, so firms frequently rely on other competitive factors, such as payment for order flow and other inducements, to determine to which market center to route customer orders.
The amount of quote competition in the options markets has increased since 2000. For the most actively-traded options series, there are at least four exchanges quoting at the NBBO for more than half of the trading day, and the NBBO is at the minimum increment for a significant portion of the trading day.
Because standardized execution quality statistics are not provided by each of the options exchanges, most firms analyze only the execution quality provided to their own customer orders. The lack of standardized, widely available execution quality data may affect thorough best execution reviews by firms.
The Report concludes that these findings support the Commission’s efforts to encourage the options markets to quote in penny increments and support the need for standardized execution quality data in best execution analyses for the options market.