Reposted from an article at Investors Business Daily

After Weighing Their Options, Other Exchanges Follow Its Lead

Posted 1/27/2006
Compared with today, options trading in the late 1990s was a sleepy little industry, with about 1.5 million contracts a day tallied by four floor exchanges.
Now the daily number is 6 million contracts a day by six exchanges. The largest equity options exchange, with 33% market share, is International Securities Exchange, (ISE) referred to as ISE.
ISE didn’t even exist until 2000, when it opened the first all-electronic options exchange.
Options trading hasn’t been the same since. Neither has ISE, which has averaged 60% revenue growth the past five years and is closing in on $200 million in yearly sales.
By providing a faster and more efficient way to trade options, ISE caused overall trading volume to soar and electronic-enabled trade competition to heat up, watchers say.
The Boston Stock Exchange has debuted its own all-electronic exchange.
Traditional floor-based options exchanges — including the Chicago Board of Options Exchange, the former equity options king — have created hybrid electronic trading platforms.
Meanwhile, the New York Stock Exchange — which will soon offer electronic trading, thanks to its upcoming acquisition of Archipelago Holdings (AX) — also plans to delve into options trades. So does Nasdaq. (NDAQ)
ISE officials say they welcome the competition.
“Philosophically our view is that the more automation there is in the marketplace, the more efficient markets become and the larger they can grow,” said Chief Executive David Krell.
All the new competition has kept ISE’s market share flat of late, though its volumes have grown dramatically.
Some of the most recent growth in the options market has come from hedge funds, says Tony McCormick, vice president of equities and options at Charles Schwab & Co. He expects that trend to continue.
“More money managers and investment advisers will look at options as a way to enhance their portfolio,” McCormick said.
He says ISE has gained a loyal following among professional and retail traders. But institutional customers are a harder sell. Larger institutional trades often “get shopped around” at regional exchanges, said McCormick.
The options market is still dominated by individual investors. Institutions have historically shied away from options trades because the market wasn’t sufficiently large or liquid. That’s been changing over the last few years.
CEO Krell expects institutional business to provide the options market — and ISE — with its greatest growth.
To tap into that market, ISE’s sales and marketing teams are targeting institutions. The exchange also has enhanced functionality to better facilitate institutional trades.
ISE looks to grow its fledging options index business, too. Nearly two-thirds of index option trading volume occurs through exclusive, licensed products of rival exchange CBOE, says analyst Richard Herr of Keefe, Bruyette & Woods.
ISE has petitioned regulators to end CBOE’s exclusive licenses in favor of multiple listings. That effort has been unsuccessful.
Meanwhile, ISE has begun to license other indexes and set up proprietary indexes where it sees a void in the market.
It recently launched the ISE-CCM Alternative Energy Index and the ISE-CCM Nanotechnology Index, developed with Cronus Capital Markets.
Also new is ISE’s market data and information business, which it began to sell in the last quarter.
“We view it as adding revenue without very much in expenses because we are sitting on all this data already,” Krell said.
Starting in the second quarter, ISE plans to make available up to three additional price levels in both bids and offers, which Krell says would appeal to institutions interested in larger deal sizes than those currently on display.
New Frontiers
Other new areas are farther off. ISE is exploring electronic links to make it easier for foreign investors to place options orders in U.S. markets. It’s also looking into equity trading on its own platform.
“We have interest in a lot of areas — equity trading, fixed income, currencies — where we can utilize our technology, platform and distribution network,” Krell said.
Leveraging all that to new areas such as equity trades could help bolster the bottom line, analysts say.
“Much of their trading system is paid for,” Herr said. “So any volume from equity trading could be mostly profit.”
ISE will report fourth-quarter and full-year 2005 earnings on Tuesday. Analysts polled by First Call expect ISE to post quarterly profit of 26 cents a share.
They see 2005 earnings rising 22% to 94 cents a share and 2006 profit moving up 15% to $1.08 a share.