- In the US listed equity option market, a single clearing house clears all trades
- But in Europe, many exchanges own their own clearing house
- This means fungibility is not possible
- Changes in exchange traded equity options clearing is under way in Europe
By Gary Delany
The US listed equity option market can be seen as a single unit, despite being composed of 14 exchanges. A single clearing house, OCC, clears all the trades. Each of the exchanges compete for order flow, using product, fee and technology innovation to attract business. Most of the options traded are multiply listed and are thus tradable at all exchanges, with the exception of proprietary products like CBOE’s SPXSM index options.
Positions for multiply listed US equity options can be established on one exchange and closed out at another, with the position at OCC reflecting both legs of the trade. The US Securities and Exchange Commission mandated that all exchange traded US equity options should use OCC as the clearing house.
Many European exchanges own their own clearing house, unlike the situation in the US
where a single clearing house clears all trades. Photo: iStock
This straightforward approach has enabled the US equity option market to flourish, delivering to users the benefits of transparency, liquidity and product range, while also enjoying economies of scale that keep the cost of clearing among the lowest in the world. Margin offset between positions also keeps costs down for users.
For most market users apart from the largest, access to the 14 US equity option exchanges is via some form of smart order router. Most investors are unconcerned with which exchange their order is executed on, but they are interested in the best price.
In Europe, the market structure is very different.
Many European exchanges own their own clearing house, the so-called vertical silo model. This means that trades can only be cleared at their own clearing house and fungibility (opening a position on one exchange and then closing it with an offsetting trade at another exchange) is not possible. Lack of a shared clearing house also means that there is no margin offset between related positions held at different exchanges.
Finally, the economies of scale that could be generated from processing higher volumes on a single platform are not available either.
The chart below shows the fragmented nature of the European exchange traded equity option landscape.
Source: The Options Industry Council (OIC)
And shown in relative terms in the following chart.
The contrasting size of the US and European markets by contracts traded is shown below.
Source: The Options Industry Council (OIC)
Change in exchange traded equity options clearing is under way in Europe and will be addressed in MiFID 2, but the date for the publication of MiFID 2 rules has been delayed until January 2018. There continues to be vigorous lobbying by the opposing factions. One side is keen for customers to continue to use exchanges’ own vertically siloed clearing houses, while the other side wishes to offer customers choice on where they clear.
Finally, research firm Tabb Group estimated that market maker share of trading in the US equity option markets was about 48% in 2014. We do not have comparable figures for European exchanges, but given the lack of fungibility between European exchanges, market maker participation – and thus liquidity and tightness of quote – may be lower.
For more information on OCC, click here for a fact sheet.
— Edited by Gayle Bryant
Gary Delany is European director of the Options Industry Council.
For more information on the value and importance of the listed options markets, plus a comprehensive listing of OIC commissioned studies, please click here
The Options Industry Council (OIC) is an educational organization funded by OCC, the world’s largest equity derivatives clearing organization, and the U.S. options exchanges. The mission of OIC is to increase awareness, understanding and responsible use of exchange-listed options among a global audience of investors, including individuals, financial advisors and institutional managers, by providing independent and unbiased education combined with practical expertise. Learn more about OIC at www.OptionsEducation.org.
The opinions expressed are the author’s own.
Options involve risk and are not suitable for all investors. Individuals should not enter into Options transactions until they have read and understood the risk disclosure document, Characteristics and Risks of Standardized Options, which may be obtained from your broker, from any exchange on which options are traded or by visiting www.OptionsEducation.org. None of the information in this post should be construed as a recommendation to buy or sell a security or to provide investment advice. ©2016 The Options Industry Council. All rights reserved.
SPXSM is a service mark of Chicago Board Options Exchange, Incorporated.