Dark Trading Regulations and Options Market Liquidity: Evidence from the Canadian Market

Abstract

This study investigates the impact of dark equity trading regulatory restrictions on the options market liquidity in Canada. In late 2012, the Canadian market regulator introduced a new dark trading regulation, referred to as the “Minimum Price Improvement” (“MPI”). It requires dark orders to provide at least one full tick size of price improvement relative to the prevailing best bid and ask price in the lit equity market. This study finds evidence that dark equity trading regulation imposes a mixed effect on the options market makers’ behaviour, therefore affecting options market liquidity. Specifically, both call and put options markets become less liquid, in terms of relative bid-ask spreads, under the new rule. In contrast, the size of market depth at the best bid and ask quote increases. Traders in call options market also face a higher level of execution costs after the regulatory change.