Latest Nasdaq options glitch highlights ongoing market problems

By John McCrank

NEW YORK (Reuters) - Nasdaq OMX Group Inc closed its second-largest options market for much of Friday after a spike in volume hampered the exchange's ability to accept orders and distribute quotes, the latest glitch to hit U.S. market operators.

The Nasdaq Options Market (NOM), which accounted for about 8 percent of U.S. options volume last month, was halted at 10:36:57 a.m. EDT (1436 GMT) and remained shut through the rest of Friday, Nasdaq said.

In a statement, Nasdaq said it determined that it was "in the best interest of market participants and investors to cancel all open orders...and to continue to market halt through the close." A Nasdaq spokesman declined comment beyond that statement.

While the halt had minimal effect on the markets, it was the latest in a raft of other industry glitches and issues in recent months and years that have raised concerns about the soundness of market infrastructure.

The problems have prompted a flurry of testing by exchanges, including NYSE Euronext's first-ever IPO simulation ahead of Twitter's highly anticipated IPO in an effort to avoid the costly problems that hit Nasdaq following Facebook's market debut.

Last week, Nasdaq had to contend with a 45-minute halt in options trading on some Nasdaq stock indexes and in August, a three-hour shutdown in all Nasdaq-listed shares.

Friday's incident came on a day with overall below-average volume in the options market. After the halt, most people were able to route option orders away to other market centers rather quickly, said J.J. Kinahan, chief strategist at TD Ameritrade.

Equity options trading continued to take place on 11 other venues, including Nasdaq's PHLX and BX Options exchanges. Equities trading was not affected. Nasdaq said it would cancel all open orders on the all-electronic NOM book.

While exchange-listed options trading volume in October was up 24 percent from a year earlier, according to clearing organization OCC, Friday was not an especially busy day. About 15.1 million contracts changed hands, falling short of the average daily trading volume of 17.1 million contracts for the last 22 trading days, according to Trade Alert.

GLITCHES GALORE

"Some of these things have happened because of the interconnectedness and the complexity of the U.S. equity markets," said Bill Brodsky, chairman of options exchange CBOE Holdings Inc , on the sidelines of the World Federation of Exchanges annual meeting in Mexico City on Wednesday.

"Automation has occurred at such a rapid pace, and yet the basic structure of the markets was designed before people were measuring things in milliseconds and recognizing that the markets would become virtually totally automatic."

Human error was blamed for the 45 minute trading halt in options trading on some Nasdaq stock indexes last week. On August 22, all Nasdaq stocks, including Apple Inc , Google Inc , and Facebook , were halted for three hours after a spike in volume triggered a software flaw in a Nasdaq-run system that receives all traffic on quotes and orders for the exchange operator's stocks.

Following that problem, the U.S. Securities and Exchange Commission called the heads of all of the exchanges to Washington on September 12 to discuss ways to strengthen critical market infrastructure and improve its resilience when technology fails.

The exchanges have to report back to SEC Chair Mary Jo White by November 12. Last week, SEC member Luis Aguilar called for stricter penalties against exchanges for market disruptions.

TESTING ON THE RISE

"I think we'll all be better off as a result of the meeting and the work that comes out of it," said Brodsky.

CBOE experienced a glitch in April that shut down the Chicago Board Options Exchange, the No. 1 U.S. stock-options market, for half a day, preventing trading in options on two of the U.S. market's most closely watched indexes.

Part of CBOE's focus since has been to make sure it can cut over to its backup systems more quickly, said Brodsky.

At NYSE, where a bug in new software being rolled out in September briefly led to a trading halt across U.S. options markets, more testing is going on as well.

The New York Stock Exchange held its first-ever simulated IPO last Saturday in anticipation of high volume for Twitter's forthcoming market debut.

Those tests were done in an attempt to avoid the types of problems that Nasdaq experienced during Facebook's 2012 IPO, when a tremendous volume of orders on the first day of trading exposed a glitch in Nasdaq's system. That ultimately prevented timely order confirmations for many traders, leaving them unsure about their exposure for hours, and in some cases for days afterwards.

Major market makers estimated they lost collectively up to $500 million in the IPO. Last week, Nasdaq said it would voluntarily pay out a maximum of $41.6 million to market makers, though some are still seeking more restitution via arbitration.

(Reporting by John McCrank; Editing by Gerald E. McCormick, Nick Zieminski and Ken Wills)