 
When is a trader a professional trader?
U.S. options exchange operators agree on this: you’re a pro if your trading activity generates an average of at least one order per minute during a six-and-a-half hour trading day.
But in an increasingly complex electronic market, industry consensus on the precise methodology for how orders are counted has unraveled. No longer is it as simple as “a trade is a trade.” This has muddied the delineation between a professional trader and a retail investor.
Retail investors are commonly awarded allocation priority and more favorable trading fees in comparison to professional traders. Introduced in 2009, the ‘Professional Customer’ designation was intended to ensure that these market structure benefits were truly rewarding the end users.
Professional Customers were defined as any non-broker-dealer who placed more than 390 listed options orders per day on average, in a given month, for its own accounts, across all exchanges.
But as rapid-fire algorithmic trading has proliferated over the past six years, interpretations on what constitutes a single order watered down the Professional Customer rule, according to some market operators and participants. That has resulted in some professional traders transacting as Customers, enjoying benefits they weren’t meant to receive, possibly distorting market structure.
In a bid to harmonize and clarify the Professional Customer rule, NYSE Options published regulatory guidance on its Amex and Arca exchanges in September. The guidance includes specific provisions to address both multi-legged, complex orders and algorithmic orders. The guidance states that for complex orders with five or more legs, each option leg will be counted as a separate order. Additionally, NYSE Options specifies that any order that cancels and replaces an existing order should be counted as a separate order, helping address cases when a single “Parent” order is entered which then generates many “Child” orders throughout the day. There is an exception to this requirement for “single-strike algorithms” when Parent orders generate multiple Child orders, but all of them are on the same side of the market and for the same option contract.
In a September 29 letter to U.S. options exchange operators, the Securities Industry and Financial Markets Association requested that exchanges adopt the NYSE interpretation of the Professional Customer rule. “SIFMA strongly supports the harmonization of non-competitive options exchange rules as a means to promote market certainty and minimize investor confusion,” SIFMA said in the letter.
The decline in the efficacy of the Professional Customer rule has been gradual, according to Steve Crutchfield, Vice President and head of options markets at NYSE.
Steve Crutchfield, NYSE Options
“When applied as intended, the Professional Customer designation helps the market operate efficiently, and in the best interests of investors. But we have to be certain that as the marketplace evolves, we are applying the rule intelligently,” Crutchfield told Markets Media. “Any loopholes can really defeat the purpose of this rule, so it’s important to take steps to address them.”
One top executive from a large electronic market maker supports shoring up the Professional Customer designation. “Some people say it is a complicated rule when it’s actually very straight-forward; it clearly refers to ‘an order’,” said Mike Juneman, managing director at Chicago-based Citadel Securities. “What has created confusion is that a few exchanges are defining an order differently, with the hope of attracting flow.”
“The SIFMA Listed Options Committee voted unanimously to support the stricter NYSE interpretation,” Juneman added. “Ten out of the twelve exchanges seem to agree with this interpretation or might adopt rules that are even stricter, which would be a positive development for the market.”
James Hyde, Senior Director of Options at NYSE, characterized NYSE Options’ Pro Cust interpretation as a pragmatic solution. “It’s a true compromise within the two most important carve-outs,” he said. “In the complex range, one can have up to four legs count as a single order. And where a child order is simply updating a price in the same series, it rightfully affords the Customer needed flexibility in order to promote healthy liquidity in the market.”
From SIFMA’s perspective, “We felt the current guidance needed some strengthening and clarification, to ensure retail has priority on the book and that there is a clear distinction between Priority Customers and Professional Customers,” said Ellen Greene, managing director at the industry advocacy group.
“From a compliance perspective it is important for the rule to be harmonized across all exchanges so that firms can accurately mark Customer orders,” Greene said. “We see a lot of technical development and innovation, and a growing use of algorithms in the market — these new tools give more Customers the ability to use trading strategies that may resemble those employed by professional traders.”
Added Greene, “This is a very complex issue, with a lot of broad ramifications. It’s important that as the markets have grown more sophisticated, that we are able to properly identify behavior amongst participants, and also have consideration for market makers providing liquidity, because the liquidity they provide is extremely important. They have a lot of rules and regulations that they need to follow on the various exchanges that they quote on.”
Markets Media sought views on the Professional Customer rule from NYSE Options’ three largest competitors, specifically whether the exchange operators would go along with SIFMA’s request.
International Securities Exchange provided the following statement: “As the exchange that first introduced the Professional Customer designation, ISE agrees with SIFMA’s goal to achieve harmonization of the rule across exchanges in order to ease the compliance burden on our members, while preserving the important benefits the designation delivers to market participants. Similar to the approach taken to Obvious Error rule harmonization, we are supportive of a collaborative industry dialogue that involves our regulator, the exchanges, and member firms on the best approach to harmonization.”
A spokesperson for CBOE Holdings declined to comment. A spokesperson for Nasdaq did not provide a comment.
Featured image by XY/Dollar Photo Club
