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January 1, 2005

Ready for Demutualization: BOX and PIP Are Forcing Rivals to Fight Back With Better Services

By Mark Longo

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  • Ready for Demutualization: BOX and PIP Are Forcing Rivals to Fight Back With Better Services

Talk about dog-eat-dog. The U.S. options industry seems headed for a vicious round of fee cuts and price improvement rebates as the exchanges wrestle each other for order flow. This comes as the options exchanges, responding to savage competition, are opening the doors to public ownership. The upstart electronic Boston Options Exchange (BOX) - which only accounts for about three percent

of total U.S. equity options volume - is in the middle of this fracas. Its radical price improvement process - PIP - has forced others to look more closely at their models. One fear is that the trading volume on BOX could rise significantly as more firms learn about and try the PIP.

The CBOE, for one, is worried. "You have to be crazy to ignore things that are going on in the industry even if you don't philosophically agree with them," said Bill Brodsky, Chairman and CEO of the Chicago Board Options Exchange, at a recent industry conference in Chicago. "We are not going to sit by and just allow one aspect of the business to happen without having a response. Our thought is that there are inherent flaws in the PIP process and we would rather improve on it rather than just copy it."

The war between the options exchanges is about more than deep discounting. Technological advances have changed the dynamics of trading. Another johnny-come-lately, the electronic International Securities Exchange, clearly had the wind at its back when it launched itself. Now the BOX has forced a bout of industry introspection. For some, the route to success is demutualization. Here is a fancy word that describes an exchange's transition from a limited membership organization to a shareholder-based corporation.

The Philadelphia Stock Exchange, a floor-based options exchange, recently demutualized. Meyer "Sandy" Frucher, Chairman and CEO of the Philly mart, says demutualization is no surprise. "It is an intermediate step toward a certain amount of repositioning," Frucher told the Chicago conference. "You need to position yourself so that you have currency with which you can strike strategic alliances."

Frucher added that exchanges would eventually become one-stop shops. "You're going to have to move more toward the European model, the Eurex, Euronext model, which has equities, options, futures and a technology company all under the same roof," he said.

With the BOX joining the fray earlier this year, the options marketplace is crowded. Kenneth Leibler, Chairman of the BOX, used the conference session to simultaneously pitch and then shrewdly downplay his exchange's PIP. "PIP represents 10-15 percent of our overall volume, certainly a minority of total trading volume in the BOX market," he said. "Average price improvement has been over $2 a contract. It is not penny pricing but actually forty percent [two cents] of the nickel spread is returned to the customer in the form of price improvement."

Still, one executive is skeptical. Michael Bickford, senior vice president of the American Stock Exchange, told the conference: "Ken talks about two cents out of nickels, but I'm willing to bet that a lot of that is two cents out of dimes."