IDEM: THE Client Price Improvement

Borsa Italiana releases for its IDEM derivatives market the new CPI (Client Price Improvement) functionality, an additional tool for the execution of pre-agreed trades.

Mifid 2 introduced a full transparency regime for all derivatives transactions with a size below the LIS (Large in Scale) threshold, therefore preventing - within the rules of the markets - the execution of any bilateral transaction below such threshold, which differs by product. With the CPI functionality, Borsa Italiana makes it possible for intermediaries to continue offering liquidity to their clients, under certain quantity and price conditions, provided that the trade is offered first for execution into the public order book to check the availability of better prices posted by other market participants. This mechanism is fully compliant with the transparency regime set by the Authorities.

The functionality therefore offers significant advantages to all parties involved:

• to the market participant, who can now benefit from an additional tool to execute transactions requested by its clients, with a size below the LIS threshold
• to the client, who has the possibility to achieve a price improvement
• to the whole market, by encouraging a tightening of the spreads available on the  public order book

Characteristics and requisites of the new CPI functionality

The new CPI functionality will be available initially only for FTSE MIB options and single stock options, including the weekly expiries.

The functionality can be activated above a minimum size: 20 lots for FTSE MIB options and 10 lots for FTSE MIB weekly options. With regards to price conditions, the maximum allowed deviation from the best prices available on the order book (so-called BBO - Best Bid and Offer) is 20% in these two cases. If the functionality is activated for single stock options, the minimum size is equal for each underlying to the corresponding minimum quoting size obligation for Primary Market Makers (stock options) and Designated Market Maker (weekly stock options) while the maximum allowed price deviation from BBO is 20% for American-style options and 40% for European-style options.

When a market participant agrees with a client a transaction that respects all of the characteristics requested to activate the CPI functionality (i.e. instrument, price and quantity), before the transaction gets executed with that counterparty at the pre-agreed price, the details of the transaction are published in the order book for 500 milliseconds plus a randomized extension period of up to 100 milliseconds.

During this phase, called “Price Improvement Period”, all market participants can post better prices in the order book for the client who could therefore achieve a price improvement for the whole quantity or for a portion of its options trade.

In any case the client is guaranteed the execution of the transaction under the pre-agreed terms, thanks to the commitment of its own capital by the trade counterparty. The interaction with the order book provides the client with the possibility to check for and achieve better price conditions.

Target of the CPI functionality

The functionality is available to all market participants, however its characteristics make it attractive especially for institutional intermediaries.

For example, the multiplier of FTSE MIB options is equal to 2.5 euro per index point, therefore an option with a 23,000 index points strike has a contract value of 57,500 euro. Considering that the minimum quantity to activate the CPI functionality on a FTSE MIB option is equal to 20 contracts, the minimum notional investment is 1.15 million euro. For FTSE MIB weekly options the minimum size would be 575,000 euro.

Looking at single stock options, for example for Intesa Sanpaolo options it is possible to activate the CPI functionality with a size of at least 160 lots, corresponding to a notional value of 320,000 euro if we consider a 2 euro strike option.

Example

An example can help us better understand the advantages offered by the new CPI functionality.

The Client has agreed, with its counterparty F, the execution of a trade on a FTSE MIB option at a buy price of 286 index points for a quantity of 20 lots. The order is injected in the market and the Price Improvement Period (PIP) starts. At the end of the Price Improvement Period, the Client order is matched for 10 lots at 284 index points with counterparty L and for 10 lots at 286 index points with counterparty F. The first 10 lots benefit therefore from a price improvement (284 index points instead of 286). Overall the Client has lowered its average buy price from 286 to 285 index points thanks to the CPI functionality.