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Do (Should) Brokers Route Limit Orders to Options Exchanges That Purchase Order Flow?

Published online by Cambridge University Press:  06 April 2020

Robert Battalio ,
Todd Griffith  and
Robert Van Ness
Robert Battalio*
Affiliation:
Battalio, rbattali@nd.edu, University of Notre Dame Mendoza College of Business
Todd Griffith
Affiliation:
Griffith, todd.griffith@usu.edu, Utah State University Jon M. Huntsman School of Business
Robert Van Ness
Affiliation:
Van Ness, rvanness@bus.olemis.edu, University of Mississippi School of Business
*
Battalio (corresponding author), rbattali@nd.edu
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Abstract

We examine whether options exchanges’ pricing schedules affect broker order routing behavior and limit order execution quality. We find that some brokers seemingly maximize the value of their order flow by selling marketable orders and sending nonmarketable orders to exchanges that offer large liquidity rebates. Other brokers appear to bypass liquidity rebates by routing both marketable and nonmarketable orders to exchanges that purchase order flow. Using a decision by the Philadelphia Stock Exchange (PHLX) to change its trading protocol, we provide empirical evidence that brokers can enhance limit order execution quality by routing nonmarketable limit orders to options exchanges that purchase order flow.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 56 , Issue 1 , February 2021 , pp. 183 - 211
Copyright
© Michael G. Foster School of Business, University of Washington 2019

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Footnotes

We thank NASDAQ for providing order data and ITG for providing data regarding the costs associated with taking and providing liquidity on various options exchanges. We also thank Amber Anand (the referee), Jennifer Conrad (the editor), Shane Corwin, Michael Doherty, Robert Jennings, Katya Malinova, Giang Nguyen, Carol Osler, Jeff Smith, Jim Upson, brownbag participants at Indiana University and the University of Notre Dame, seminar participants at UTEP, and the University of Memphis, and participants at the 2017 Mid-Atlantic Research Conference in Finance, the 2017 Washington University Theory Conference, the 2017 Northern Finance Association Annual Conference, the 2017 Financial Management Association Annual Conference, and the 2017 Annual Market Structure Conference (by the Financial Industry Regulatory Authority and Columbia University).

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