The alternative option exchange TOM has released a fresh research report. The option prices across the three exchanges with options on Dutch stocks are compared.

The best bids and offers in the market on Eurex, Euronext and TOM are compared for December 2015. TOM hired reputable market research company Markit to do the job.  Good decision, because nobody would argue with Markit.

Apart from winning the battle in the Dutch option market, there’s another good reason to release this report. The Markets in Financial Instruments Directive 2 (MiFiD 2) will start next year. And it could be a shock for the market. This will put legal pressure on brokers to give clients the best execution of their orders. If TOM supplies evidence their prices beat the other exchanges, they have a strong point for banks to connect to TOM.

You can read the four page Dutch Option Market Analysis here (pdf).

the Markit analysis

There are three kind of lies. Lies, damned lies and statistics. But let’s skip the skeptical part for a second. Markit proved the option market with the highest bids and lowest offers is TOM. Markit checked four possible scenarios for option bids and offers. There are more combinations possible, but it gives a good idea of the tightest quotes.

• One side is on the best bid together with the market on another exchange, and the best offer is behind the best offer. Say in an option TOM is 1.00 – 1.05, while other exchange are 1.00 – 1.04.
• Both sides are on the best bid and best offer. Say TOM is 1.00 – 1.05, just as Euronext or Eurex.
• The bid is exclusively the best. Say TOM is 1.01 – 1.05, while other exchanges are 1.05.
• The bid and offer is exclusively the best. Say TOM is 1.01 – 1.04, while other exchanges are 1.00 – 1.05.

Spreads on TOM are tighter

On all four situations, the spreads on TOM are tighter than Euronext and especially Eurex. With a small margin, the bids and offers on the TOM option market give the sharpest prices. And checking the full four page press release, it’s clear in the liquid large caps (ING, RD etc) the difference is larger. Note that a spread in this analysis also can consist of small limit orders instead of regular quotes.

No cherry picking

Checked whether TOM was involved in cherry picking of research outcomes – like analyzing 20 variables and only releasing the positive ones. But this isn’t the case, the research is legit. It takes every option into account, very liquid ING options and very quiet NSI options. If the research would give more weight to heavily traded options, the outcome would be even better for TOM.

Maybe TOM asked market makers to temporary improve their quotes on TOM for the month of December? Checked this too, no such thing.

What about lies and statistics?

Mark Twain said something smart about lies and statistics. While the statistics in the Markit report are completely true and legit, they don’t tell the whole story. There are four issues with the research report.

First the apparent lousy quotes on Eurex. Quoting on Eurex is a bit different, market makers aren’t obliged to quote very deep in-the-money options. They stick to where the action is. Around the at-the-money strikes. This means Eurex quote performance suffers from punishment on lack of in-the-money quotes. You can argue if that’s justified.

Second, volume matters. A very sharp bid for just one contract may improve the “European Best Bid and Offer” spread. But if you really want to execute a serious trade, this one contract isn’t of much use to trade against. You want to know where you can find the best regular size to trade against.

Third, exchanges aren’t competing on best option prices. Exchanges don’t send quotes. Market makers fill the screens with quotes. And in general, the market makers in these stock options are the same persons on all three exchanges. And these market makers send the same quotes with the same spreads on all exchanges.

Last but not least, better option spreads on the screens don’t necessarily mean the market is better in the real world. You could even assume the better statistics for TOM actually mean there are passive retail orders within the quoted bid-ask spread which don’t get filled. Assume, for the sake of the argument, a situation where small retail orders on TOM within the bid-ask spread never receive a fill, while these would be executed on Euronext immediately. This would give TOM great statistics, while the retail investor on Euronext would get a better fill.

So, which option exchange wins?

TOM can claim the best quotes and passive orders can be found on their market. Former monopolist Euronext can still claim most of the volume in Dutch stock options is traded with them (though more index options are traded at TOM). And third, Eurex can point out their exchange charges less. Especially for professionals, the clearing costs at Eurex are lower (exercises and assignments).

If TOM and ICE Clear could match the Eurex fees, it could really make a difference for the professional participants. If retail brokers such as Binck could pass on the lower fees for their retail clients – maybe even match DeGiro – the liquidity would  leave Euronext. But that’s a long shot. Anyway, Markit made clear a best execution policy can’t do without connecting to TOM.

• Eurex, Euronext, TOM