Programming Note: If you enjoy this piece about exchanges, check out my “Market Structure and Liquidity” series with The Options Institute. The next installment is 9/23 at 11 CT and you can register here.
This was a dream job for a high school kid.
I could hang out with my friends, make cash money tips, and sling ice cream that was made not 10 feet from the cash register, to lines of summer evening revelers. When someone ordered a milkshake, you quickly learned how to make just a little bit extra to pour off into a Dixie Cup. Quality control.
Folks are usually in a good mood when they’re getting dessert, so we had very few customer service issues. And fortunately being a 15 year old kid who relied on a bike not a car, my metabolism could handle unfettered access to barrels of frozen confections.
Summer turned into winter, and the job migrated to hand packing pints for the wholesale business. The bougie grocery store in town white labeled our product, and we delivered the densest pint around. At a time when organic produce was only available in co-ops, people were already paying $8 a pint for extra fatty milk and direct from Madagascar vanilla ice cream.
While it was only a year of my life, the memories and lessons from that first job are indelible. Sure the boss man could be goofy and would joke around with us, but there were distinct expectations, and he had a quality product and reputation to maintain. To this day it’s my benchmark for good ice cream.
If you think a teenager enjoys this kind of access, imagine what a first grader thinks? My daughter for two years has been incredibly consistent about her career goals - to be an ice cream shopper. Not a buyer, but the owner of an ice cream shop. It’s the logical conclusion of someone who wants to get ice cream whenever she wants. Most people start businesses because they are passionate about the product - but this is distinctly about becoming your own biggest customer.
You know who else does that? Trading firms.
This week the biggest news was not the FOMC rate decision, but the launch of yet another options exchange. MX2 is the third exchange (second for options) in the “Members Exchange” group.
Back when I was still scooping ice cream, it was common for the members to own the exchange they traded on. Even going back to the Buttonwood tree, the brokers and traders were also the stockholders in the mutual. This was done through “seats” which were a way to purchase access and gain certain trading rights. A great wave of consolidation swept through in the new millennium and slowly exchange groups began consolidating under corporate umbrellas.
Pension fund allocators and quarterly reports replaced the members only dining rooms. Market data fees became the leading source of revenue. The biggest users of exchange services used to have an equity stake, and now they were being increasingly squeezed.
No longer content with this, a group of the largest market participants (retail brokers, financial banks, liquidity providers) formed their own exchange, and started trading equities in 2020. An options exchange was the natural progression, and in 2024, in their first year of launch achieved a roughly total 3% market share (6.1% if you exclude proprietary products like SPX, VIX).
The first exchange was traditional, with maker/taker fees and price/time allocations. (You get paid to post orders, and are charged slightly more to remove liquidity. Orders are allocated on a first come first served basis at each price level. ) As with anything brand new, the differentiating factor was no legacy cruft, and lightening fast matching engines.
But the MX2 exchange does something that is both difficult and rare in market structure - truly innovate on pricing. The biggest non-exchange players in the industry are steering their own transaction venue in a unique direction, posing an interesting threat to legacy groups.
The lifeblood of options markets are customers. Brokers, exchanges, and market makers all lack purpose without natural orderflow. The end customers of liquidity are the reason everyone opens up shop. Protection of the customer is not only commercial, it’s baked deep into the regulatory framework. It is the primary lens by which the Securities and Exchange Commission evaluates any rule changes or product launches.
The fee schedule at exchanges is typically abstracted away from most end users of options. Retail brokers aren’t charging anymore, and that’s thanks to payment for orderflow arrangements combined with the rebates or zero fees wholesalers get upon execution of customer orders. This effective but somewhat convoluted structure is exactly what MX2 is targeting. Here the customer payment is baked right into the transaction fees.
No matter how a customer order is executed on the new venue - the customer gets a rebate. Whether they’re posting liquidity or removing bids and offers, a credit goes back on each contract. And a bigger credit for liquidity taking orders.
Beyond that, the schedule is completely flat. The CBOE fee schedule is 24 pages of tables and codes. MX2 is one table with three rows and four columns. That’s a little unfair to the legacy venue, as they provide a much more complex set of offerings, but it is directionally telling.
Combine this with high participation rates for Lead and Preferred market makers, and there’s a lot of reasons why orderflow would migrate here. The determinism is valuable to a wholesaler who has purchased an order. When routing to MX2, they are guaranteed to get a rebate back on the full customer side of the order, and can trade significant portions of it if they’re on the best quote, regardless of timing.
While there might be better rebates for certain order types elsewhere - particularly at volume tiers - the backstop of knowing a flip from maker to taker doesn’t wreck your economics is a significant benefit.
A diverse ownership pool means there are many parties who want to see this succeed, and benefit from not only individual order fees, but revenue per contract economics as an owner. It’s a toll road where the heaviest users are also the owners, and subsidize their own tolls by encouraging the right kind of drivers to use their road. (Liquidity, unlike highways, benefits from more users.)
This might all seem like the arcane corners of market structure, with the beneficiaries being a bunch of well heeled prop shops. That is true on the face of it. Brokers could certainly start paying customers to trade (Public already does), but my guess is that customers start seeing the benefits elsewhere.
The better the pricing of transactional fees gets for wholesalers, the more competitive they are able to be with price improvement. MX2 is just one component of a complex network of exchanges and routing tables, but it provides a distinctly interesting offering for orders that are taking liquidity. And because that’s the best place for a customer to order to go, more and more market makers want to be there to get those. That increases size, but leads to price competition also.
So the positive feedback cycle continues.