The impact of a premium based tick size on equity option liquidity

1. The impact of a premium based tick size on equity option liquidity ThanosVerousis, OwainapGwilym & Nikolaos Voukelatos Discussion by Georges Hübner 7th Financial Risks International Forum BIG DATA IN FINANCE AND INSURANCE, Paris March 20-21, 2014

2. Summary and contributions • The paper studies the impact of a reduction in tick size on the option market (NYSE LIFFE Amsterdam) on various indicators of liquidity. • The focus is on two events: • The decision to reduce tick size from 5 to 1c for options priced below or at 20c (2 June 2009) • The subsequent decision to reduce extend the reduction for options priced below or at 50c (1 Apr 2010) • The sample is built on 4 windows (2x2) surrounding the event dates • The research methods rely on • The comparison of sample means of liquidity-related variables before and after each event • A linear regression analysis including event-related dummies • The results generally support the conjectured hypotheses • Increase in liquidity-related measures • Decrease in the market ability to absorb larger trades 2 The impact of a premium based tick size on equity option liquidity Discussion at BIG DATA IN FINANCE AND INSURANCE, Paris, March 20

3. Major comments • Where’s the largest potential contribution? The application to option markets! The other hypotheses are mostly re-tests of well-documented phenomena. • This dimension is only explicitly addressed through Hyp 7-9: • Hypothesis 7: Liquidity will increase by less as moneyness increases • Hypothesis 8: Spreads for OTM options written on more volatile underlying assets will be narrower after the implementation of the PBTS • Hypothesis 9: Option spreads that are affected by the PBTS will exhibit lower volatility reflecting an overall increase in liquidity • What can be interesting in terms of determinants of liquidity and trading preferences? • The importance of option maturity (pure moneyness only partially reflects proba of exercise) • The liquidity of the opposite option (put-call parity), presumably not affected by the change in tick size • The underlying’s perceived risk through the implied volatility and the difference with historical volatility • The pricing uncertainty through the volatility smile 3 The impact of a premium based tick size on equity option liquidity Discussion at BIG DATA IN FINANCE AND INSURANCE, Paris, March 20

4. Othercomments • Methodology • Splitting the sample by option type and look at pre- and post-revision descriptive stats can be OK for preliminary checks, but the paper should refine the causal relation • Is there any non-contemporaneous effect to be identified? • Is there any causality between liquidity variables? • Presentation of hypotheses • Lack of organization in the presentation of hypotheses/measures. Consider merging sections 3 and 4, and translate each hypothesis operationally • Hypothesis 3 is quite obscure. How is it formally tested? • Segmentation among Market Makers • Is there any evidence of differing impacts between PMMs, on the one hand, and CMMs on the other hand? The effect is not likely to be straightforward as PMMs are more likely to be hit by the rule (as they quote all options) while CMMs must make a certain number of transactions in order to retain their license • Second event window: impact of Flash Crash of May 6, 2010 (-3,3%) 4 The impact of a premium based tick size on equity option liquidity Discussion at BIG DATA IN FINANCE AND INSURANCE, Paris, March 20