>>>>>>>>>>> EQUITY OPTIONS MARKET MODEL.

Transcription

1 >>>>>>>>>>> EQUITY OPTIONS MARKET MODEL

2 I. MARKET MODEL OVERVIEW To meet the competitive challenges of U.S. options exchanges and to facilitate the development of the Canadian options market, the Montréal Exchange is using an automated market model for option trading in Canada. This market model - unique in North America - provides increased transparency, easier access, fewer barriers to entry and ensured competition, all of which will contribute to more liquid markets with improved pricing for investors. The equity options market model s main features are: open, equal access with no seat to buy or permit to rent; a central, anonymous, electronic order book; a strict price/time algorithm (FIFO) for order matching; a display of the five best limits in the central order book; competing market makers on each class; permanent quotes on all series with maximum spread. All market participants are on an equal footing with client orders having the same status as professional orders in the central order book. All orders in the book are immediately executable at the posted price and quantity. It is important to remember that the client priority rule for brokers still exists in that client orders take priority over their own brokers orders at the same time and price; however, once entered in the central booking system, all orders are treated equally. Orders are entered into the Montréal Automated System (SAM) through the Approved Participants communication networks. Access to trading is provided through order routing systems for investment advisors or via the internet for many discount brokerages. Speed of execution is a function of network strategies as well as give up agreements organized by the introducing broker. To foster the development of the options market, market making firms have been selected to provide live, firm quotes - both bids and offers - on assigned option classes. These orders not only provide users with immediate liquidity; they also facilitate the price discovery process. 2

3 II. MARKET MAKING SCHEME > The competing market maker system is designed to provide the most significant element for improving the quality of the options market: visible competition. > With multiple, competing market makers for an option class, market participants and their clients will benefit from tighter bid and offer spreads as each attempt to be first at the best price to meet the strict time priority trading algorithm. > Increasing the number of market makers will also increase the size of posted orders on the bid and offer as well as the depth of the order book. > Moving from a specialist model and opening up market making opportunities to a wider number of interested participants will ensure that the costs associated with price discovery are reduced and that end-users can be more confident they are trading at the best price. Market making firms are given financial consideration (fee reductions) and extra bandwidth consideration in return for maintaining some minimum market presence. The responsibilities of market making firms are described in article 6395 of the Rules of the Exchange and in the market maker agreement. Designation of market making firms The Exchange selects market making firms candidates on the basis of the following criteria: 1) be an Approved Participant of the Exchange; or 2) be a client of an Approved Participant if he demonstrates that he has the necessary resources (capital, technology and human) to meet operational requirements. There is no pre-determined limit to the number of market makers for an individual class. Such a limit (if any) will be determined by the Exchange on a case-by-case basis as a function of market quality and business considerations only. Market making assignment For every new listing, each market making firm is offered one assignment. At least two market making firms must declare their interest to effectively list the new class. Each market making firm assigned on a class will compete against the other market making firms assigned on the same class. Responsibilities are equal for all market making firms (market makers). The Exchange evaluates market makers periodically to ensure that they are fulfilling their market making responsibilities. Pre-opening and opening phases obligations Market makers are obliged to provide continuous two-way prices for all options instruments within their class, commencing at 9:30 a.m. (or five minutes prior to the established opening time, whichever is earlier). Market makers are expected to furnish additional liquidity - beyond their basic obligations - when an opening could occur at an unreasonable price. >>>>>>3

4 Continuous trading phase obligations Market makers are required to continuously maintain a market on both the bid and offer sides for all instruments in the class throughout the continuous trading phase. Closing phase obligations Marker makers are responsible to ensure that bids and offers in compliance with the pre-defined spread commitments are posted at all times for all instruments assigned. The last 30 seconds of the market session are not taken into consideration for the purpose of performance evaluation. However, it is the market makers obligation to post bids and offers at the close in order to ensure the good order of all end-of-day activities. Minimum order size commitment There is no minimum size commitment. Nevertheless, all market makers will have their performance monitored and evaluated. A key element of this evaluation will be based on the size of the committed positions posted by the market maker in relation to his peers. The size commitment will be taken into account in the selection process of new market makers. Request for Quotes (RFQ) obligations Market makers are obliged to respond with a bid and an offer to all RFQ messages issued for their option class where the size of the RFQ exceeds their posted market quantities for the instruments up to a maximum of 20 contracts. In this case, the commitment criteria regarding the bid and offer spread is suspended. The market maker must respond to each RFQ within 30 seconds of its issuance and maintain a bid and offer for 15 seconds. Protection against simultaneous execution The Exchange has implemented software that will prevent multiple trade executions between market makers during the course of normal market making activities. Termination of market making assignment The Exchange reserves the right to terminate a market making assignment. The Approved Participant will be advise of the poor performance of its market making on a particular class in order to allow time to take appropriate actions to rectify the situation. If the performance does not improve within a reasonable timeframe, the assignment will be withdrawn. Should a market maker wish to terminate his role as market maker for a given class, the Exchange must be advised four weeks prior to the effective date. The following criteria are used to determine the termination of market making assignment: trading volume substantially and consistently below average of other market makers on the same class; quality of bid/offer spreads and order size consistently below other market markers on the same class; consistent failure to meet the obligations of a market maker for the class; material change (human resources or financial capital) to the market maker s status; infraction to the Exchange s Rules; maximum bid/offer spread. 4

5 III. TECHNOLOGY ISSUES > Access to the option trading platform is via SAM (Montréal Automated System). > Through regular data dissemination services, the best five bids and offers, including the size and price for each posted option is continuously broadcasted. > Transmission bandwidth choices The Exchange enables Approved Participants to access its trading platform through an open Application Protocol Interface (API). Approved Participants have the opportunity to select any Independent Service Vendor (ISV) system that meets their trading requirements and that has connectivity to the Exchange trading platform. The Exchange enables: 1) all Approved Participants to send two messages a second; or 2) all market making firms to send one bulk quote message a second for every two classes of option that they are required to post markets on. Market making firms are given extra bandwidth so they can generate more bids and offers and continually refresh their prices in relation to the underlying product changes. > SAM provides pre-opening and pre-closing sessions where order entry is possible without execution. > Opening match - The matching algorithm used by the option system to calculate opening prices considers all orders in the book and determines the price at which the maximum number of contracts that can be executed to be the opening price: if one or two prices satisfy the maximum quantity criteria, the price that will leave the fewest resting orders is selected; if still two or more prices meet both criteria, the price that is closest to the previous day s settlement price is selected. Following the opening match, SAM is operational and trading is carried out through a first-in, first-out basis (FIFO) except when part of the allocation is subject to an execution guarantee. > Marker maker order message format - Market makers use a bulk quote order (compressed message that contains numerous orders for different series of equity options) to send messages to SAM. It provides market makers with the capacity to rapidly adjust the large number of instruments on SAM. Bulk message format provides price up-dates on instruments on the same option class (up to 75 instruments simultaneously with a bid and offer for each). Marker makers are permitted to submit one bulk order per every two assigned classes per second. A market maker may have a single bid and offer per instrument via other order message formats should he wish to participate on a class that he is not assigned. Each order (bulk or standard) is treated and posted in time sequence. >>>>>>5

6 IV. OPERATIONAL POLICIES AND PROCEDURES > Trading halts - The market for any option class is halted when there is a halt on the underlying security. However, for US-interlisted securities, the option classes may continue to trade if the market is interrupted on an exchange for technical reasons (the Exchange may decide to suspend trading if market quality is poor and that client protection indicates that this is the best course). > Trade cancellations A trade on SAM resulting from an entry error could be cancelled by the parties agreeing to it within 15 minutes following its execution. Approved Participants have the responsibility to identify erroneous trades. If an erroneous trade is identified, the market participant must fax the standard form at (514) A trade is not cancelled: 1) if the cancellation request is made outside the delay; 2) if the spread is inferior to the spread determined by the market official (No Cancel Range); 3) if the market official does not have sufficient information to determine the acceptable market price; or 4) if the request is irregularly made. > Tick size Rules are: 1) if premium is equal to or less than $0.10, tick is $0.01; 2) if premium is greater than $0.10, tick is equal to $0.05. > Strike prices For the pricing of an option class in which the underlying cash instrument is trading: 1) at $10.00 or less, strike price interval is $1.00; 2) higher than $10.01 and lower than $50.00, strike price interval is $2.50; or 3) $50.01 and higher, strike price interval is $5.00 with occasional variation to meet market requirements. > Execution of offsetting orders (cross) Approved Participants must contact Market Monitoring at for entry of simultaneous orders. > Request for Quote (RFQ) An Approved Participant is able to issue an RFQ (indicating only the equity option class and the quantity). RFQ is anonymous and does not display any information pertaining to the identification of the Approved Participant who transmitted the RFQ. Market officials control RFQ message traffic to ensure that abuse does not occur. RFQ messages are included in the Exchange s broadcast and are visible to all market participants. Responses to RFQs are considered live orders with the same treatment as any other limit order on the order book. The issuer of any RFQ does not have any priority in execution against the orders responding to the RFQ. To be executed, the order must be entered to the system. RFQs are not accepted during the pre-opening phase. The issuer of a RFQ is under no obligation to enter an order after an RFQ. > Combined orders The Exchange supports the entry of combined orders (a contingent order involving two or more exchange-traded instruments such as straddles, call and put spreads or options and the underlying share or futures) into SAM by Approved Participants. Assistance in the execution is provided by market officials at

7 V. SUMMARY The Montréal Exchange believes that the new market model for trading Canadian equity options is a significant development for investors who currently use options as part of their investment or hedging strategies, as well as for those who will use them in the future. Market participants will see a visible improvement in the quality of the Canadian options market in terms of liquidity, ease of execution and pricing. The transparent and competitive environment for the pricing of options will enhance investor confidence in the options market. Improved access and fewer barriers to entry will attract new entrants into the Canadian marketplace. Combined, these factors should promote a marketplace that is at a minimum as successful as the Exchange s international counterparts, and one that will be considered as a benchmark by our clients in the future. This document has been prepared solely for information purposes to the intent of the persons interested in Bourse de Montréal Inc. markets. Although care was taken when preparing this document, Bourse de Montréal Inc. takes no responsibility for revisions, errors and omissions. All references to rules, specifications and obligations, and all amendments thereto, are subject to the Rules of Bourse de Montréal Inc. and the Canadian Derivatives Clearing Corporation. >>>>>>7

8 A AGE AGU AC AL ANP ATY BLD CM LCM ZMC BMO LBM ZBM BNS LBQ ZBQ NA LNA ZNA RY LRY ZRY TD LTD ZTD ABX LBA ZBA IFM BCE LBC ZBC BVF BBD LBB ZBB BNN CAE CNQ CTR TEU CP CAS CLS LLS ZLS GIB CIX CSN CNR CL BCB DSG DFS DTC ENB ECA >>>>>> >>>>> Tour de la Bourse P.O. Box 61, 800 Victoria Square Montréal, Quebec H4Z 1A9 CANADA Bourse de Montréal Inc. - March 2003