Options Forum: What Demutualizing Means

Steve,

You've recently written about the Philadelphia Stock Exchange (PHLX) demutualizing. Can you explain what that means in terms of the industry and its effect, if any, on trading?

-- J.B.

Nomenclature aside, the Philadelphia Stock Exchange is basically an options exchange, as nearly 80% of its volume now comes in the form of option contract execution. The exchange was established in 1790, making it the first licensed securities exchange in the U.S. But just as its heyday as a leading stock exchange has long since passed, its stature in the options industry has also declined.

As of October, its market share of the U.S. option market was just 11.85%, tying for a distant third with the crumbling American Stock Exchange among the five currently operational exchanges. With about a 31% market share of equity options, the surging all-electronic International Securities Exchange has displaced the Chicago Board Options Exchange, which has about a 26% equity option market share, to become the new leader less than three years after its launch.

Keeping Up With the Joneses

Demutualization basically changes an exchange from a nonprofit organization owned by members to a for-profit business owned by shareholders. The process separates ownership interest of trading rights, such as seat-holders and member firms, from equity interests in the company or exchange itself.

Separating trading rights, such as seat-holders and member firms, from equity interests in the company or exchange itself, is one of the first steps in simultaneously eliminating entrenched conflicts of interests, says David Krell, president and CEO of the International Securities Exchange. Aside from creating a structure that helps separate operational and trading issues from oversight and regulation, demutualization provides more latitude and opportunity for growth.

The PHLX's decision to demutualize is simply a continuation of an already established trend. The Pacific Exchange was the first to demutualize its equity operations in 2000, and in two weeks, its members will vote on demutualizing the options portion of the business.

"I expect the vote will have an overwhelming majority to move forward with the process we started three years ago," says Dale Carlson, vice president of corporate communications at the Pacific Exchange.