Transactions in listed options take place on exchanges through open outcry or electronic matching.
If you’ve been trading stocks for some time, you’re already familiar with the basic procedures that govern options trading. Individual investors who wish to buy or sell options place orders through their brokerage firms. Where an order goes from that point depends on both the brokerage firm’s policy and the exchange or exchanges on which the options contract is traded.
Who is a specialist?
Traders acting as specialists lead the auctions for each options class, and are in charge of maintaining a fair and orderly market, which means that contracts are easily obtainable, and every investor has access to the best possible market price. Each exchange has a particular structure of specialists, who may sometimes be known as designated primary market makers (DPMs), lead market makers (LMMs), competitive market makers (CMMs), or primary market makers (PMMs). Other traders, sometimes known as agents, trade options for their clients, sometimes buying from and selling to the specialists.
New technology has supplemented or replaced the traditional open outcry system on some exchanges. Instead of traders gathering in a pit or on a floor, transactions are executed electronically, with no physical interaction between traders. Auction prices are tracked and listed on computers, and orders may be filled within a matter of seconds. Some options exchanges are totally electronic, and many use a hybrid of open outcry and electronic trading.
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The majority of the orders that come to those exchanges are filled by an automatic execution computer that matches the request with a buyer or seller at the current market price. Transactions requesting an away-from-the-market price, or one that is higher or lower than the current market price, are held in an electronic limit order book. Once trading reaches the requested price, those orders are the first to be handled.
Proponents of electronic trading argue that the anonymous nature of the transactions means that all customers — whether represented by an experienced broker or not — have equal footing, which makes the market fairer. They also point out that since the costs of running an electronic exchange are lower, the transaction fees for trades may also be lower.
Standart of exchange
Listed options are traded on regulated exchanges, which must adhere to SEC rules designed to make trading fair for all investors. Nearly all equity options are multiply listed, which means they’re available for purchase and sale on multiple exchanges. Contract terms and pricing are standardized so that the contracts are fungible, or interchangeable. You might give an order to purchase an option that is executed on one exchange, and later give an order to sell the same option that is executed on a different exchange.
What is cryout in options trading?
In the early years of options trading, the floors of exchanges operated as open outcry auctions. Buyers and sellers negotiated directly with each other, using shouts and hand signals to determine prices in a seemingly chaotic — but in reality, very structured — process. Open outcry is similar to the auction system used for stock trading, but relies on a more frenetic negotiating atmosphere.
Today, however, nearly all options transactions take place electronically, and only rare orders above a certain size or those with special contingencies attached are passed on to brokers working on the floor of the exchange. The manner in which a trade is filled is invisible to the investor, regardless of whether it happens electronically or through open outcry. In either case, when a trade has been successfully completed, investors are notified by their brokerage firms.
Options exchanges and players
Before 1973, options trading was unregulated and options traded over the counter (OTC). The Chicago Board Options Exchange was the first to open, and the list has expanded regularly over the years. For a current list of exchanges, please see OIC’s website.
These organizations all have a role to play in options trading:
OCC is the actual buyer and seller of all listed options contracts, which means that every matched trade is guaranteed by OCC, eliminating any counter-party credit risk.
The Options Industry Council (OIC) is a group sponsored by the options exchanges and OCC. OIC provides education for investors about the benefits and risks of trading options.
The Securities and Exchange Commission (SEC) is a US federal agency that governs the securities industry, including the options industry. The SEC protects investors by enforcing US securities laws and regulating markets and exchanges.
Clearing the way
One of the innovations that made trading listed options workable from the start was establishing a central clearinghouse to act as issuer and guarantor for all the options contracts in the marketplace. That clearinghouse, which became the Options Clearing Corporation in 1975, has approximately 130 member firms that clear trades for the brokerage firms, market makers, and customers who buy and sell options.
Because of OCC, investors who open and close positions, trade contracts in the secondary market, or choose to exercise can be confident that their matched trades will be settled on the day following the trade, that premiums will be collected and paid, and that exercise notices will be assigned according to established procedures. Like the options exchanges, OCC has streamlined the clearing process — evolving from runners who made the rounds of member firms twice a day to a totally electronic environment.
Where Are Options Listed? by Inna Rosputnia
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