Payment for Order Flow And Option Internalization
56 Pages Posted: 4 Apr 2022 Last revised: 4 Mar 2024
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Payment for Order Flow And Option Internalization
Payment for Order Flow and Asset Choice
Date Written: March 13, 2022
Abstract
We investigate execution quality and payment-for-order-flow (PFOF) in the options market. Option trades generate high PFOF. While all option trades execute on-exchange, option exchange rules facilitate internalization by retail wholesalers. We exploit variation in designated market maker (DMM) assignments, minimum tick size, and auction allocation rules, showing that option internalization is imperfectly competitive. These imperfectly competitive rules protect option market maker profits, and allow market makers to pay high prices for retail option order flow.
Keywords: Payment for Order Flow, PFOF, Broker, Routing, Options, Robinhood
JEL Classification: G14, G11, G12, G20
Suggested Citation: Suggested Citation