PIP Transactions, Price Improvement, Informed Trades and Order Execution Quality


  • The authors are particularly grateful to Richard Roll for his insightful comments on a previous version of this paper. They are also grateful to A. White, T. McCurdy, Z. He, E. Errais, to the participants in the Joint Conference of the Canadian Operational Research Society and Optimization Days (Montreal 2006), FMA European Conference (Barcelona 2007), and EFMA Conference (Vienna 2007) and an anonymous referee of this journal for helpful remarks. Thanks are also due to S. Meknassi, K. Gikas, H. El-Ibrami, V. Valentir, David Felkai and J. Pagé for their able assistance. Data for the study was graciously supplied by the Montreal Exchange with the consent of the Boston Options Exchange. Financial support from the Chair in the management of derivative products is gratefully acknowledged. Correspondence: N. Khoury.


This study focuses on innovations in order execution processes within the context of the Boston Option Exchange (BOX). More specifically, it examines the impact of the Price Improvement Process (PIP) on options quoted, effective and realised proportional spreads. We consider the PIP as a mechanism that allows the market maker to ‘internalise’ the transaction. We show that PIP transactions are associated with wider bid/ask proportional quoted spreads than non-PIP transactions, in spite of the temporary narrowing of the effective proportional spread during PIP. We identify informed traders by focusing on the direction of trade. Using an original data set, we show that PIP transactions follow signals in the form of buy/sell orders by informed traders. We also show that PIP is a mechanism that allows the market maker to internalise a position in the same direction as that of the informed trader. We conclude that PIP does not improve the efficiency of the market but simply allows the market maker to benefit at the expense of uninformed traders.