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May 10, 2006

NYSE Arca Looks to Make Splash in Options

By Nina Mehta

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The old Archipelago Exchange is hoping to replicate its success in equities on a new stage: options.

Last September ArcaEx acquired Pacific Holdings, which includes Pacific Exchange, for $91 million. It announced it would replace the Pacific's newly developed PCX Plus trading system with a "next generation options trading platform" that would utilize some of the order-matching components from ArcaEx's equities platform. The new options platform is due to launch this spring. But past performance is no guarantee of future performance.

"The main question is: Will Arca/New York be the same entrepreneurial firm that Arca was five years ago, or are they going to be the NYSE?" asks Tom Sosnoff, CEO of thinkorswim Group, a retail options trading firm in Chicago.

The firm that started as Archipelago ECN in December 1996 has come a long way. In 2000 it partnered with Pacific Exchange to form ArcaEx, which absorbed the Pacific's equities trading business. ArcaEx went public in 2004. This past March it merged with the 213-year-old New York Stock Exchange and is now part of NYSE Group.

For now, NYSE and NYSE Arca remain separate securities exchanges with different business cultures and platforms. NYSE Arca includes the old Pacific Exchange, which has been renamed Arca Options Exchange, or Arca OX, according to technical documents on NYSE Group's web site.

As of mid-March NYSE Arca had not submitted a proposal with the Securities and Exchange Commission for its new Arca OX trading platform. SEC approval is required before the new system can launch.

NYSE Arca declined to be interviewed for this article because the company is in a quiet period as a result of the merger.

Arca OX has a steep hill to climb. Of the six U.S. options exchanges, the old PCX ranks fifth in market share, with 10 percent of the industry volume.

"The challenge is to get people to take a fresh look at them," says Jeff Shaw, head options trader at Timber Hill, an options market-making firm. Timber Hill, which is part of Greenwich, Conn.-based Interactive Brokers, manages about 360 specialist books on the PCX Plus platform, making it probably the largest specialist firm on NYSE Arca's options exchange.

Arca OX must differentiate itself in an industry that has become increasingly competitive since the upstart, all-electronic International Securities Exchange launched in 2000 and began winning volume. Multiple listings of options took off in August 1999, largely in anticipation of the ISE's entry into the market. The ISE-the first exchange approved by the SEC in more than a quarter-century-built up a market share through anonymous, screen-based trading that now rivals that of Chicago Board Options Exchange, the granddaddy of U.S. options exchanges.

In 2004 Boston Options Exchange launched with a more traditional ECN-like market structure and a controversial price improvement mechanism that enabled market makers to price-improve orders on the exchange's limit order book. This innovation gained ground, prompting the ISE and CBOE to come up with their own electronic price-improvement auction mechanisms.

Playing Catch-Up

The current PCX is an "also-ran," says Jamie Selway, a managing director at institutional agency broker White Cap Trading and a former chief economist at Archipelago.