Equity option liquidity after the introduction of the Premium Based Tick Size on NYSE LIFFE Amsterdam

On June 2, 2009, NYSE LIFFE Amsterdam reduced the tick size of options trading

below €0.20 from €0.05 to €0.01 and on April 1, 2010, the exchange increased the price

threshold to €0.50. In this paper, we study the effect of that tick size reduction on the liquidity

of individual equity options. We show that, in general, quoted and traded option liquidity

increased but at a rate decreasing with option moneyness. Real costs have fallen more for the

lower priced contracts. Importantly, we show that the ability of the market to absorb larger

trades has diminished after the change in the tick size. We document a substantial increase in

quote revisions that implies that the decrease in tick size has potentially led to a worsening of

the order book, as it allows traders to take advantage of the price priority rule and step ahead

of larger trades. Finally, the decrease in the tick size has led to an increase of speculative

trading behaviour.