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Wednesday, August 22, 2007

No, No, A Thousand Times No

The rumor mill is abuzz, once again, with the possibility of E*Trade merging with TD Ameritrade.  I have one plea, based on the needs of online investors and traders:  Please Don’t Do It. 

Yes, TD Ameritrade has some noisy hedge funds trying to force them into a merger.  It would be a disaster from a customer point of view – which is the point of view of my “Electronic Investor” column.  Both firms have huge customer bases, as they are currently #2 and #3 in terms of number of accounts.  (Schwab is #1.)

They serve very different needs, though, and I believe a merger, though it might make certain hedge fund managers happy, would make millions of customers miserable. 

And one columnist. 

Posted by twcarey on 08/22 at 08:12 AM
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Saturday, August 18, 2007

An Improvement on Penny Pricing

WE ASKED OUR READERS TWO WEEKS AGO what they thought of the Securities and Exchange Commission’s test of penny pricing for options, and whether the new format had affected their trading habits. Maybe it was the summer doldrums or the arrival of bigger problems elsewhere in their portfolios, but the response by Barron’s readers was uncharacteristically underwhelming.

All we can figure is that penny pricing isn’t having a huge effect.

What did emerge from our related discussions with market participants, however, was an alternative to penny pricing that might be more far-reaching and useful to the options market.

The SEC introduced penny pricing of options at the start of this year in a pilot program involving 13 underlying stocks. Most options are still priced in increments of a nickel, which means that a one-tick change in price translates to a $5 change in the cost of a single contract. (Each contract gives the holder the right to buy or sell 100 shares of underlying stock).

Reducing the increment to a penny would make a one-tick change alter the price by $1. The SEC’s hope is that smaller increments will make options less expensive for retail investors and allow everyone to turn a profit on smaller price moves.

The SEC’s current plan is to expand the test by an additional 22 stocks on Sept. 22, then add 28 more next March.

Going in, the fear among market makers was that the additional data required for smaller increments would overwhelm quote providers and cause serious slowdowns. That fear has not been borne out, because the providers have come up with technological fixes that reduce the volume of information traffic.

BUT ANOTHER early concern has proven prescient. Recent studies show that the number of contracts available to trade at a particular price is significantly lower than it was before the test.

Peter Bottini, an executive vice president and head of trading at the brokerage optionsXpress, compared volume in the 13 tested options over the last three months of 2006 (when prices were quoted in nickels) with the three months ended in June (when prices were quoted in pennies). Six of the 13 underlying stocks had significant drops in contract-trading volume; five were relatively unchanged; and the two most active issues, iShares Russell 2000 Index (ticker: IWM) and PowerShares QQQ (QQQQ), both popular exchange-traded funds, enjoyed increases.

Bottini, who was a market maker at the Chicago Board Options Exchange for nine years before joining optionsXpress (, believes that the markets need an entity that is obliged to provide liquidity—like a market maker, who has an incentive to take the spread. When that potential reward is substantially reduced by the penny spreads, liquidity providers go away.

Bottini believes penny pricing is causing the market to fragment. Customers use trading tools and screeners to find opportunities; if they decide to place a trade for 20 contracts and can get only five, they are frustrated. Bottini has seen the quote size, which is the number of contracts available at a particular price, drop 75% to 80% for many of the stocks in the test.

To be sure, others see it differently. At a recent Sandler O’Neill investor conference, Interactive Brokers President Thomas Peterffy said the firm’s trading volume in penny-priced issues has risen 99%, which more than compensates for a 32% drop in profit per contract. Steve Sanders, an executive vice president, says Interactive ( very much favors extending the program.

Neville Golvala, president of ChoiceTrade (, reports that his firm has seen an uptick in volume in the QQQQs, but not much else. ChoiceTrade, he says, would “cautiously support” expansion of the pilot to another 50 names by March, “if liquidity at the top of the book is not compromised.”

However, both Golvala and Bottini say that their customers would prefer to see more dollar strikes, which would make additional at-the-money options available, rather than further expansion of the penny-pricing test.

If the goal of the SEC is to encourage options trading, dollar strikes would be more effective than penny pricing. Currently, most stocks have options listed in $2.50 increments—say, $7.50, $10, $12.50 and $15. If, for example, a stock is trading at $9.25, the lower $7.50 option is too far out of the money to attract much interest. However, there would likely be a great deal of interest in a $9 option, which paired with the existing $10 option presents two prices close to being in the money.

According to Bottini, the exchanges would like to expand dollar strikes, but the SEC is hesitant, citing a worry about a spike in quote traffic.

“The quote providers [a group that includes Bloomberg and Barron’s parent, Dow Jones] are going to scream if dollar strikes are mandated,” says an industry insider who asked not to be named. “They will whine that they don’t have enough capacity even now, and that dollar strikes will kill them.”

Nevertheless, dollar strikes seem to me to be a more useful trading tool than penny pricing.

Perhaps it’s time the linkages between exchanges were beefed up to handle the additional quote traffic so that investors can be better served.

The SEC is taking comments on its penny-pricing test, a route it seems to favor over dollar strikes. Still, it wouldn’t hurt to visit its Website ( and tell them what you think.

ONLINE-BROKER NEWS: TradeKing ( just introduced The Options Playbook, by Brian Overby, TradeKing’s “Options Guy” and its director of education. The book features a breakdown of more than 30 of the most common options strategies. It also defines numerous terms, explains how volatility affects the options trader, delves into concepts like “rolling” and outlines margin requirements for various trades. I found it clear and often entertaining. You can pick it up on Amazon or at the TradeKing Website for $34.95.

Interactive Brokers recently expanded its global direct-access platform to include Australian stocks and Swedish stock options. This brings the total number of market centers offered under the IB Universal Account to 72, across 17 different countries.

Published in Barron’s, August 13, 2007.

Posted by twcarey on 08/18 at 06:00 AM
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Friday, August 17, 2007

Schwab Melts Down on Day NASDAQ Peaks

Bad time for a case of “human error,” Schwabbies. 

Yesterday (August 16), the NASDAQ announced that it had the biggest day ever in its history for total matched volume, with approximately 3.73 billion shares traded.  But around 9:45AM Pacific time, Schwab’s ( online trading site, along with its phone lines, shut down due to what they said was “a human error that restricted trading capacity,” according to an Associated Press report. 

Other brokers I contacted yesterday, including thinkorswim, optionsXpress, ChoiceTrade, TradeStation, and E*Trade reported that they were experiencing no trading-surge-related problems. 

Having covered online brokers since 1992, I’ve seen plenty of meltdowns.  Most of them happened during the mid- to late-90s, when online brokers were setting up shop and trying to simultaneously cope with the surge of interest in trading.  Capacity planning was a huge issue, and one that I query every year when I put together my online broker surveys for Barron’s. I once likened Schwab’s ongoing efforts to spiff up their platform and avoid the constant crashes as trying to change a tire on a car that was barreling down the freeway at 100mph. 

The one and only time Schwab answered the my question, “What percentage of your accounts can be online simultaneously?” they said 15%.  I made a fairly big deal about it at the time, so they have since refused to answer question with anything specific.  This year, their answer was, “We are committed to ensuring the stability and security of our systems. Our capacity is at a level which can handle many times the maximum historical demand.”

To be fair, there are several other brokers who dance around this question, including Fidelity who says, “We do not track capacity in this way,” and E*Trade, which states, “Not publicly disclosed; E*TRADE employs open ended architecture with scalable capacity.” TD Ameritrade flat-out did not answer the question at all, even with evasive dancing. 

Most other brokers reported capacity between 95% and 250%. 

Posted by twcarey on 08/17 at 08:42 AM
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