Block trades in options markets
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Abstract
This paper documents the evolution of block trading in the crude oil options market, following the reduction of the minimum permissible block size threshold in October 2012. Block trading, that was sparse prior to this change, currently accounts for over 30% of the trading volume in WTI crude oil options, a large portion of which involves option trading strategies. We compare the execution costs of large/block orders across trading venues before and after the October 2012 regulatory change, in order to gain a better understanding of the factors behind the recent increase in block trading. We find that the upstairs market attracts orders with lower information content. However, compared to large trades in the downstairs market, block trades face higher total execution costs, which potentially serve as compensation for the high search and negotiation costs surrounding the execution of option trading strategies. The research presented in this paper was co-authored by Sayee Srinivasan, CFTC Chief Economist, who wrote this paper in his official capacity with the CFTC and Dr. Eleni Gousgounis who wrote this contract pursuant to CFTC contract CFCE-OCE-14-CO0137. The Office of the Chief Economist and CFTC economists produce original research on a broad range of topics relevant to the CFTC’s mandate to regulate commodity futures markets, commodity options markets, and the expanded mandate to regulate the swaps markets pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act. These papers are often presented at conferences and many of these papers are later published by peer-review and other scholarly outlets. The analyses and conclusions expressed in this paper are those of the authors and do not reflect the views of other members of the Office of Chief Economist, other Commission staff, or the Commission itself.