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April 1, 2002

Payment for Order Flow Back From Extinction?

By John A. Byrne

Traders on the Chicago Board Options Exchange - alarmed by the gradual erosion in the CBOE's share of equity options volume - are clamoring to reinstate payment for order flow.

The controversial practice - eliminated last year by most exchanges in response to widespread criticism - is now seen as a way to draw back business lost to rivals, some CBOE pros contend. That contradicts critics, who suggest that rebates damage the quality of the customers' executions.

Nonetheless, traders on the CBOE, the nation's largest options exchange, are worried. Decimal pricing, a sluggish market, and more competition, have reduced the CBOE's share of the options business to about 30 percent over the past 12 months. Its share of the options market - which peaked at about 50 percent last year - has declined by 40 percent.

In the same period, the upstart electronic International Securities Exchange has seen its market share growing to almost 20 percent of the total volume, making it the third largest options exchange behind the CBOE and the American Stock Exchange. The Amex is the number two options exchange in the U.S.

Still, payment for order flow has not been completely eliminated at the CBOE. But, by one estimate, it has dramatically declined since its peak.

At the Ford Motor Company's Options pit at the CBOE, market makers recently signed a letter sent to senior management urging the reinstatement of rebates, according to a published report. Those payments would be funneled through a fund earmarked as marketing fees.

A spokesman for the CBOE was not available for comment.