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August 23, 2005

NYSE Looks at Options: The Options Business Ain't What It Used to Be

By Mark Longo

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  • NYSE Looks at Options: The Options Business Ain't What It Used to Be
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(Traders Magazine, August 2005) -- Unless you have been living in a monastery for the last six months, you have undoubtedly heard about the earthshaking merger between NYSE and ArcaEx/the Pacific Coast Exchange (PCX). Although this merger has caused a great deal of consternation on Wall Street, the shockwaves are also being felt in the endless war zone of the Chicago option markets. The delicate balance of power that has existed for the past few years has just been turned on its ear, and the new battle lines may change the way securities are traded in the U.S.

Although the NYSE's sudden decision to gobble up ArcaEx surprised many people in the equities industry, consolidation is not a new trend in the options world. In fact, for the last few years, consolidation has been the norm. The driving factors for this consolidation have been the incredibly shrinking margins in the industry along with the resulting increase in risk for liquidity providers.

Economies of scale have become increasingly important as firms began to look for ways to lay off risk and lock in profits across a wide array of products. Some of the new players to consolidate were the market makers. Small market making firms and independent options traders were quickly gobbled up by large specialist firms as the cost and risk of maintaining trading operations rose. The next ones to consolidate were the order flow providers. The market crash in 2000 erased the portfolios of many key clients, while reduced stock prices and volatility levels made options a less attractive alternative to equities. Small brokerages could no longer afford the risks associated with maintaining an options book and were forced to either close or sell out to firms with deeper pockets.

That just left the exchanges. However, instead of going along with everyone else, they decided to buck the trend. While everyone else in the industry was consolidating, the number of U.S. options exchanges actually increased by 50 percent. "Everyone but the exchanges has consolidated," says Meyer "Sandy" Frucher, Chairman & CEO of the PHLX. "This industry has consolidated below us. These days, you can count on one hand the number of large options specialists. Tragically, there are very few independent market makers left. As a result, all of the major players on the six exchanges are now the same."

"These days, you can count on one hand the number of large options specialists."