Coming Soon to Your PC: The Options Pit

It may be awhile before trading floors become ruins of a bygone era, but electronic options networks are preparing to fight the floors for some of the valued paper that comes their way.

The first upstart in electronic options trading, the International Securities Exchange, wants to lure institutions with lower prices. It's expected to be up and running by the end of March. Before ISE screens flicker their first blinks, however, there are major trading firms readying electronic platforms that will attempt to carry the electronic communications network, or ECN, phenomenon into the derivatives world. (ECNs match buy and sell orders for stocks and have taken order flow from the exchanges.)

At least three other operations are on the drawing board and a few of their partners have cut their teeth on screen-based markets overseas, giving them valuable experience. One, Timber Hill in Connecticut, is a major options trading firm that's now trading futures electronically in Hong Kong and has signed on firms as big as Goldman Sachs (GS Quote) to its Interactivebrokers.com platform there.

And the recent IPO filing of options market-making firm Hull Trading has sparked rumors that its tech savvy founder Blair Hull may sprinkle some of the IPO ducats among several ECNs for options trading. The firm wouldn't comment, citing its quiet period, but Hull has been an electronic trading proponent for years and is active on screen-based exchanges throughout Europe.

Old-line trading firm Cantor Fitzgerald is in discussions with the Pacific Exchange and other regional exchanges about piggybacking Cantor's worldwide U.S. Treasury futures trading network for options trading.

And then there's ePit, now pretty much just a Web site, albeit one plugging software that would allow an options market structure via the Internet.

There are, however, two problems hiding in even the best-laid plans: bandwidth and order flow.

Compared with the symbols for most stocks, transmitting options trading symbols is like shoving an informational elephant through a garden hose because of its multiple strike prices and expiration dates, factors that spawn an alphabet soup of quotes and take up tons of network capacity.

And until institutional Wall Street embraces electronic trading networks, traders say virtual or online options trading will turn out to be the party where no one shows. The best shot to insure order flow, it seems, is for these burgeoning networks to align themselves with established exchanges that need to embrace electronic platforms to stay competitive.

Despite all this, cyber-exchanges have bricks-and-mortar floor traders quaking in their New Balances. Currently, 65% of Internet traders are aggressive options traders, according to figures from a recent options industry conference.

Cantor Fitzgerald has "spoken to numerous exchanges," including the Pacific and the Philadelphia Stock Exchange -- the nation's two smaller options exchanges -- about possible partnerships for "taking Cantor's exchange technology into other markets, including options," says managing director Deborah Watson.

Cantor says it doesn't have a bandwidth problem. It built an electronic platform to trade $50 billion in U.S. Treasury futures daily and has T-1 connectivity to the world's largest banks and brokerage firms.

Customer orders may be another story. Cantor is well-known for its bond futures business but not for options; Cantor may also be reluctant to advertise the identity of current bond futures -- and potentially options -- customers, says one Chicago trading firm boss.

ISE is building a liquid market using a ring of pre-committed customers, some of which it has identified, which in turn is expected to attract more customers. "Cantor Fitz may have a hard time getting order flow from people who aren't their customers already," the Chicago exec says.

Cantor's model could be similar to Knight/Trimark (NITE Quote), the Nasdaq market maker owned in part by online brokers, the same options trader says. Cantor could link with floor firms such as Timber Hill, REFCO and Lind-Waldock, which would act as portals to a virtual exchange, give retail investors electronic access to the network and guarantee trades.

Out in San Francisco, the embryonic ePit has recruited some interesting names in its plan to create Internet software that would turn a PC into an options pit. Among them: Doug Carlston, the former president of Broderbund Software, and Rob Kovell, the head of First Options, a major market maker on the P-Coast and the Chicago Board Options Exchange.

To grab a foothold, ePit boss Rich Friesen says the company is "talking to any exchange that will listen to us." Its software/trading screens are designed for a wide-range of users, professional and otherwise. "There is no dedicated terminal," he adds. "It's all straight Internet." The ePit pilot is scheduled for late summer with a live launch expected in early 2000, Friesen says.

Comparing ePit, which won't charge membership dues, with ISE, Kovell says: "This is going to be much more democratic. With ISE, you have to have bought a membership on the network, whereas with ePit, anyone can place an order, provided they have the capital to back the trade."

Democracy can be a messy animal. According to the head of one institutional options desk who tested the ePit software, "it provides an outlet to trade anything with a lot of transparency. Great concept, but execution will be everything."

Over at the ISE, marketing chief Gary Katz is watching the potential competition. "We're the furthest along," he says. "And if this is just a Web site so far, I'm not worried. At least not yet."