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September 10, 2007

CBOE Seats: Up, Up & Away

But Other Factors Indicate Seats Could Be Overvalued

By Mark Longo

Also in this article

Seats at the Chicago Board Options Exchange are on a perennial upward climb these days. Each week, it seems, the CBOE announces a new record for the price of a seat, shattering the previous one. This has become such a regular occurrence that it's hard to believe it wasn't always the case.

Back in the late 1990s, the CBOE was in a comparable position to today concerning seat prices. The stock market was trading at lofty heights, and everyone wanted to be involved in the options business.

While equity analysts were obsessing over microprocessors and memory chips, obscene fortunes were being made-and lost-in the CBOE's trading pits. The incredible demand to trade options translated into a remarkable run-up in seat prices. This bull market for seats culminated in February 1998, with a then-record price of $735,000.

Heading To Zero

Long before the tech boom went bust, the bloom began to fade from the CBOE's rose. The rise of electronic trading, along with the dawn of multiple listing, combined for a lethal one-two punch to the CBOE's seat prices.

Although options volume remained strong after 1998, it was definitely an unsettling time to be a member of the CBOE. Competition from the International Securities Exchange loomed on the horizon. Compared with electronic trading, traditional open outcry seemed slow, inefficient and costly. Why bother leasing, staffing and maintaining an expensive trading floor when a few servers and an IT team could accomplish the same task?

With its market share eroding, CBOE members began making markets on how long the exchange would survive. Needless to say, bids greater than one year were difficult to find. It was during this dark period that seat prices hit their low of $150,000 in August 2002. At the time, even that price point seemed overvalued and a gamble. With the growing prominence of electronic trading, CBOE seats appeared to be on a one-way trip to zero.

CBOE seat prices finally bounced back in late 2002. This resurgence coincided with one of the seminal events in the derivatives world-the Chicago Mercantile Exchange (CME) IPO.

The launch of CME stock in December 2002, and the massive run-up that followed, awakened Wall Street to the enormous potential of the derivatives sector. A market that most considered mysterious and arcane had suddenly become the darling of analysts and investment bankers.

The success of the CME IPO inevitably led to speculation about which derivatives exchange was next. As the overall leader in options volume, it wasn't long before attention turned to the CBOE. Oddly enough, the same people who had earlier dismissed the exchange as a dinosaur were now eagerly speculating on the date of its IPO.

SPX Lifeline

Of course, other developments helped to boost the value of CBOE seats. The launch of the exchange's Hybrid trading system, along with an increasingly aggressive payment-for-order-flow program, finally managed to stem the CBOE's hemorrhaging market share.

In an industry rife with identical products, the CBOE also had one advantage over its competitors-monopoly products. Thanks to its stranglehold on the lucrative SPX product line, the CBOE was able to remain the top options exchange.

While the CBOE's piece of the options market may have shrunk on a percentage basis, overall options volume was expanding. This rising options tide lifted every exchange, including the CBOE, to record volume and profit levels.