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

TL;DRAbstract

On June 2, 2009, NYSE LIFFE Amsterdam reduced the tick size of options trading 
\nbelow €0.20 from €0.05 to €0.01 and on April 1, 2010, the exchange increased the price 
\nthreshold to €0.50. In this paper, we study the effect of that tick size reduction on the liquidity 
\nof individual equity options. We show that, in general, quoted and traded option liquidity 
\nincreased but at a rate decreasing with option moneyness. Real costs have fallen more for the 
\nlower priced contracts. Importantly, we show that the ability of the market to absorb larger 
\ntrades has diminished after the change in the tick size. We document a substantial increase in 
\nquote revisions that implies that the decrease in tick size has potentially led to a worsening of 
\nthe order book, as it allows traders to take advantage of the price priority rule and step ahead 
\nof larger trades. Finally, the decrease in the tick size has led to an increase of speculative 
\nt

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