Nasdaq to market new options strike listing tech to other exchanges

Last year, Nasdaq began using predictive AI in its US options markets, and now it is looking to sell that tech to others.

The exchange operator is in talks with clients to determine if the product, which uses predictive AI to estimate whether an options strike is likely to trade or not, could be used by and sold to other exchanges as part of its market technology business.

The initiative, referred to internally as the strike price optimization program, was designed to list options strikes more aligned to market demand on Nasdaq’s six US options exchanges. With about 1.5 million individual options symbols listed in the US last year, some in the industry say the operational burden of keeping pace with such growth is now too high.

A blog by the Futures Industry Association (FIA) earlier this week raised the questions of whether there are too many strikes and whether longer trading hours are more trouble than they’re worth.

In US options trading, the strike price is the price the trader will pay for the underlying security if they decide to make the trade before the option contract expires. Multiple strike prices can be listed for options belonging to the same security and expiration—say, Tesla options expiring May 17—meaning one security can carry a massive number of data points across all exchanges that list Tesla options. If the price of the stock moves significantly, strikes that were close to the old price will continue to be listed, despite attracting few trades.

We think that’s kind of the future of markets—having the dynamism where they’re actually able to react to conditions

Mike O’Rourke, Nasdaq

Nasdaq is currently editing strikes on its proprietary index options where, unlike in other options, it is the only exchange to list those specific contracts. “Literally every day, we are adding and removing [strikes]” for those options, says Greg Ferrari, Nasdaq’s vice president and head of North American exchange trading. He says there is an opportunity for Nasdaq to sell that tech to clients operating other exchanges.

The exchange is also using strike optimization for some single and multi-list options that are listed on all 17 options exchanges. In certain cases, it has been used to remove weekly strikes in order to better correlate to demand.

Given exchange rules that place limits on the number of securities for which options can be listed, part of the value proposition of Nasdaq’s strike optimization tech is to decide which securities ought to be allocated weekly options.

Development

The technology was developed by teams led by Ferrari, and Mike O’Rourke, Nasdaq’s senior vice president and head of artificial intelligence and data services technology, as part of the company’s larger AI program formed in 2016. The teams used a reinforcement learning model, created based on publicly available data from the Options Price Reporting Authority (Opra). It then exposed the model to the simulated market and trained it based on what strikes would be the most successful. It now makes predictions based on that training, picking the strikes that are most likely to trade.

The model works by taking an independent, uncontrollable variable—like the weather—to estimate the likelihood or desirability of a second dependent variable—say, the decision to bring an umbrella to work, says O’Rourke.

For strikes, the prediction might use market data from Opra and the Options Clearing Corporation (OCC) to ask what the volumes could be if a particular strike were listed. Given that prediction, the control mechanism would then ask whether the strike should be listed. High volumes in an underlying security, for example, might signal the likelihood of higher demand for more strikes within that options series.

Given the uniquely competitive and transparent nature of the US options market, if one exchange lists a strike, competing exchanges will list the same strike. While more granular strike prices allow investors greater freedom to customize their options contracts, there is growing concern in the industry that the proliferating number of strikes places an unsustainable capacity burden on the US options infrastructure.

Although Nasdaq’s offering helps to determine which strikes to list, it is also able to determine if a strike is a candidate for removal. In the industry, efforts to curb the number of options strike prices listed by exchanges, sometimes referred to as quote or strike mitigation, has been suggested as a way to address capacity concerns.

Some in the industry approached Nasdaq about using the technology to clean up strikes across US options. While Nasdaq proposed a rule in 2021 to limit the number of strikes in the outer weeklies, or option contracts with 21 to 49 days until expiry, Ferrari and O’Rourke say they see the strike optimization program as additive to the industry.

Strike optimization is just one part of Nasdaq’s Dynamic Markets Program. “We think that’s kind of the future of markets—having the dynamism where they’re actually able to react to conditions,” O’Rourke says.