The impact of a premium based tick size on equity option liquidity

On June 2, 2009, NYSE LIFFE Amsterdam reduced the tick size for options trading at prices below €0.20 from €0.05 to €0.01 and on April 1, 2010, the exchange increased the price threshold to €0.50. We study the effect of that tick size reduction on the liquidity of individual equity options. In this respect, this study is uniquely positioned in the options context where moneyness is a clear additional factor in the implementation of the tick size changes. 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 a deterioration in 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 increased speculative trading behaviour.