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Certain industries don’t cross the public’s mind until something goes wrong. The world of market structure is one of those industries.
How many of us had heard of the DTCC before GameStop blew up? How many talked about CME futures position limits before the Bitwise ETF launch? If the general public is concerned with the intricacies of clearing or the tactics of a high frequency trader, it’s more likely than not because the system isn’t working as it should.
Take payment for order flow for example. Before Robinhood disrupted the retail broker commission model, PFOF was an afterthought. Brokers didn’t build their business model around it & the public didn’t endlessly debate the topic. As commission-free trading became the norm & Robinhood went public, the conversation quickly changed.
One thing I find puzzling about the public market structure debate is how narrowly focused it is on one asset class - equities. Plenty of words & ink are spilled explaining US equity market structure in great detail to argue how it’s broken & how it can be fixed. I believe there are plenty of other markets that deserve our attention.
Take options for example. US options volumes have exploded to record highs since COVID began, leading many to argue that options activity - not their underlying stocks - are what now drive prices. The amount of money involved in options payment for order flow is larger than equities. Exchanges now generate equal, if not more revenue from their options businesses than equities. Tectonic plates have shifted under the market’s feet to make options market structure a much bigger deal than it’s been in the past.
Despite these monumental changes, the options market is still as opaque, over-looked and under-followed as ever. I consistently have trouble finding accurate data & information that tells me how the options market works, how different participants are incentivized, and where we should be challenging the system’s design.
This post tries to solve that very issue. After speaking with multiple traders, market makers & exchanges about options market structure from their perspective, I’ve been able to build a picture of the system that few in the media talk about or seem to understand. My hope is that by explaining how the system works in greater detail we can start talking about the truly important changes that need to be made rather than squabble over politics or red herrings.
Consider this post a detailed, wholistic primer on options market structure that I wish had existed when first starting out. I’ll first explain the structure by tracking a retail order from broker to exchange to clearing & settlement. I’ll then work backwards through the same trade, highlighting the complexities & angles of debate throughout the industry at each point in the cycle.
Let’s start at the source - imagine Joe Retail logs into his Robinhood account & submits an order to buy one call option in a popular name like $TSLA or $AAPL.
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