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September 22, 2005

PCX Penny Pricing Options Plan Draws Fire

By Gregory Bresiger

The Pacific Stock Exchange's proposal to trade options in pennies would be a disaster for exchanges and vendors, some of which may exit the options business, according to critics of the PCX proposal.

"It would be a nightmare for all the firms. And for the exchanges, it will require an astronomical expansion of its bandwidth," Kenneth Leibler, chairman of the Boston Options Exchange (BOX), told Traders Magazine. He noted that the BOX executes but doesn't trade options in pennies.

The PCX is a relatively small options player. It executes about 500,000 contracts a day, according to a PCX spokesman. But PCX, potentially, could become an options heavyweight. Earlier this year Archipelago Holdings completed the purchase of the PCX, which is now in the process of merging with the New York Stock Exchange.

Still, PCX competitors charge the underdog options player is ready to trade in pennies because it has almost no market share to lose. The critics also suggest that PCX could soon become a formidable competitor because it now has a deep pockets parent.

Earlier this year the PCX announced that it was going to apply to the Securities and Exchange Commission to begin trading options in pennies. A rule filing with the SEC had yet to be made as Traders Magazine was going to press. Nevertheless, PCX still expects to begin penny trading this year, according to a spokesman.

PCX officials contend that trading options in pennies-instead of the current nickels or dimes-would both help investors and narrow spreads.

Penny trading in options would also "make options markets more efficient and more transparent," according to Phillip DeFeo, PCX Chairman and CEO. "We believe spreads should narrow in many issues."

But one trading official, who didn't want to be quoted by name, complained that, "with pennies, trading in stock options would have to be updated almost every second. You would have to install miles of wires. The additional orders of magnitude would be such that many exchanges just wouldn't be able to afford it."

He added that traders might put up a penny bid just to see what the other guy is going to do. This trader also disputed the idea that there would be more options trading in pennies than in nickels.

"It's not going to really improve anything. It's going to cost a lot of money and cause a lot of problems," the trader said. However, PCX officials insist that-after spreads decline and the number of contracts initially is reduced-over the long term the business will prosper.

"Customers have been asking for this," said the PCX spokesman. "We must do this. It would be a little silly to have a platform in which you trade stocks in pennies, but trade options in nickels or dimes," he added.

An SEC official, in a speech earlier this year, endorsed a move to penny pricing in options. Trading in pennies, "could substantially reduce or eliminate payment for order flow," according to Elizabeth King of the SEC's Division of Market Regulation. King said that pennies in options could have the same effect as penny trading in stocks.

"The move to penny increments," King added, "greatly reduced spreads in those securities trading in pennies and narrower spreads have been cited as one of the factors that led to a decrease in the use of payment for order flow in securities traded as pennies. Payment for order flow could similarly be reduced in options if spreads are narrowed."

An SEC spokesman would only say that the PCX options plan is "pending." Spokesmen for the American Stock Exchange, International Securities Exchange, Chicago Board Options Exchange and Philadelphia Stock Exchange all declined comment.