Regulated Technology Diffusion: The SEC and the Impact of 'Penny Pricing' in Electronic Options Trading

Abstract:     
The Securities Exchange Commission (SEC) implemented the first phase of a 'penny pricing' pilot in the exchange-traded equity options market in February 2007. The initial phase of this trial required the six United States options exchanges to reduce the minimum bid-offer spread from five or ten cents to a penny for the options corresponding to thirteen underlying equity securities. The catalyst for this pricing change was the improved electronic capabilities of the exchanges. Over the course of the preceding decade, the exchanges invested in the development of electronic trading systems that allowed for more efficient quoting and trading of options securities. The SEC's mandated pricing change effectively redistributes the gains of innovation from the exchanges' market makers to individual investors. his paper analyses the market impact of the Penny Pilot and highlights the SEC's central role in shaping the options market's innovations and competitive environment. Beyond a reduction in bid-offer spreads, the pricing pilot has stimulated a variety of changes in trading dynamics and market structure. These repercussions include thinner markets, changes in market maker fee structures, the introduction of alternative trading venues, and incentives for the exchanges to prioritize further technological innovation.

Keywords: Innovation, SEC, Penny Pilot, Equity Options

Working Paper Series