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To Pay or Be Paid? The Impact of Taker Fees and Order Flow Inducements on Trading Costs in U.S. Options Markets

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  • Battalio, Robert
  • Shkilko, Andriy
  • Van Ness, Robert

Abstract

Consistent with prior literature, we find that average relative effective spreads are higher for venues that pay for order flow (PFOF) than for venues utilizing the maker-taker (MT) model. This relation becomes more nuanced when liquidity fees are incorporated into liquidity cost measures. For the majority of options, PFOF venues offer lower average liquidity costs net of taker fees. Net liquidity costs for the high-priced options, however, are lower for MT venues. Overall, our results suggest that the inclusion of fees and rebates can rationalize the routing of most, but not all, marketable orders to PFOF venues.

Suggested Citation

  • Battalio, Robert & Shkilko, Andriy & Van Ness, Robert, 2016. "To Pay or Be Paid? The Impact of Taker Fees and Order Flow Inducements on Trading Costs in U.S. Options Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 51(5), pages 1637-1662, October.
    • Handle: RePEc:cup:jfinqa:v:51:y:2016:i:05:p:1637-1662_00
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    Cited by:

    1. Chakrabarty, Bidisha & Cox, Justin & Upson, James E., 2022. "Tick Size Pilot Program and price discovery in U.S. stock markets," Journal of Financial Markets, Elsevier, vol. 59(PB).
    2. Wing Wah Tham & Elvira Sojli & Johannes A. Skjeltorp, 2018. "Cross-Sided Liquidity Externalities," Management Science, INFORMS, vol. 64(6), pages 2901-2929, June.
    3. Justin Cox & Kathleen P. Fuller & Robert Van Ness, 2024. "Where does ex‐dividend trading occur: An examination of trading venues around dividends," The Financial Review, Eastern Finance Association, vol. 59(1), pages 31-55, February.
    4. Suchismita Mishra & Le Zhao, 2021. "Order Routing Decisions for a Fragmented Market: A Review," JRFM, MDPI, vol. 14(11), pages 1-32, November.
    5. Li, Yubin & Zhao, Chen & Zhong, Zhaodong, 2019. "Price discrimination against retail Investors: Evidence from mini options," Journal of Banking & Finance, Elsevier, vol. 106(C), pages 50-64.
    6. Peter Christoffersen & Ruslan Goyenko & Kris Jacobs & Mehdi Karoui, 2018. "Illiquidity Premia in the Equity Options Market," The Review of Financial Studies, Society for Financial Studies, vol. 31(3), pages 811-851.
    7. Brauneis, Alexander & Mestel, Roland & Riordan, Ryan & Theissen, Erik, 2022. "The anatomy of a fee change — evidence from cryptocurrency markets," Journal of Empirical Finance, Elsevier, vol. 67(C), pages 152-167.
    8. Roseman, Brian S. & Van Ness, Bonnie F. & Van Ness, Robert A., 2018. "Odd-lot trading in U.S. equities," The Quarterly Review of Economics and Finance, Elsevier, vol. 69(C), pages 125-133.

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