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September 9, 2009

CBOE Gets Pre-Hedging

By Peter Chapman

The Chicago Board Options Exchange, as part of its drive to win order flow away from the over-the-counter market, got a big boost from the Securities and Exchange Commission.

The regulator approved a CBOE rule change that lets its members pre-hedge their options trades. Now an institutional broker can hedge an options position before putting it on.

The CBOE hopes the change will encourage more large-lot brokers to take their crosses to the exchange rather than trade them upstairs and off-board. Traders would rather lock in their hedges before taking an order into the exchange crowd. If they wait until after the options trade is completed, they are subject to the vicissitudes of the stock market, and may not be able to win favorable terms for their hedge.

The CBOE and most exchanges prohibit such "tied hedges," or pre-hedging.

Pre-hedging is a divisive issue across the financial markets as it is considered a form of front-running. The practice could put at a disadvantage both the customer order being hedged and the trading crowd competing for the order, critics claim.

The International Securities Exchange made that case to the SEC, but to no avail.

 

 

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