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December 18, 2007

Nasdaq Grabs PHLX Options Biz

By Nina Mehta

Despite more than a year of high praise for the idea of price-time priority markets in the options arena, Nasdaq last month decided to fork over $652 million for the dealer-driven Philadelphia Stock Exchange.

In recent years, Philly has resurrected itself as an aggressive, quote-focused options market. The acquisition gives Nasdaq an immediate options market share of almost 15 percent, bigger than that of NYSE Group, the U.S. subsidiary of NYSE Euronext.

Robert Greifeld, Nasdaq's president and chief executive officer, told reporters last month that Nasdaq still planned to launch its Nasdaq Options Market, the industry's seventh options exchange, early this month. The new exchange will have a price-time priority model with pricing that rewards liquidity providers and charges liquidity takers.

Greifeld said Nasdaq would operate two options markets with competing models. He added that he doesn't see price-time markets replacing market-maker-driven models in the options industry.

The largest U.S. options exchanges, the Chicago Board Options Exchange and International Securities Exchange, are quote-driven markets that together execute 60 percent of the industry's options volume. The CBOE has a floor and electronic trading, while the ISE is an all-electronic market.

In addition to market share, acquiring Philly gives the all-electronic Nasdaq a floor operation under its direct control for the first time. Philly maintains a hybrid options market, with a floor as well as electronic trading. The exchange also offers electronic equities trading, but its volume is negligible.

The options floor "is an integral piece of [PHLX's] operation," Greifeld told reporters, adding that a "substantial piece of the PHLX's current success is tied to the success of the floor." He observed that Philly and the new Nasdaq options exchange, with their different market models, are likely to appeal to "different sets of players."

Nasdaq's acquisition of PHLX, the nation's oldest exchange, is expected to close in the first quarter of 2008. Almost 90 percent of the Philadelphia exchange was owned by six broker-dealers, who bought into the market in mid-2005. Meyer ("Sandy") Frucher, the Philly's CEO, told analysts last month that the exchange's agreements with the firms to send order flow to the exchange lapsed last year. "We earned the market share we have," he said.

For the Philadelphia exchange, Nasdaq's purchase winds down a decades-long dating game. Frucher acknowledged that his exchange had gotten close to the altar several times. "But I've never gotten into the gown until now," he said. Frucher will remain CEO of the PHLX and is expected to join Nasdaq's executive management team.

Philly and Nasdaq began negotiations earlier this year and also held talks last year. Over the last two decades, PHLX has held merger discussions with at least four options exchanges and several equities markets.