Trader Mutiny Flares Up in CBOE's Ford Options Pit

The firm that won the primary market-maker spot in Ford has been blackballed by traders who buy and sell the company's popular options.
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CHICAGO -- It's not brute-style Chicago politics, but it's close.

A small scandal on the

Chicago Board Options Exchange

has been raging in the crowded

Ford

(F) - Get Report

options pit, after the firm that won the primary market-maker spot was rejected by traders who buy and sell the automaker's popular options.

In essence, the winner,

Prime Markets

, has been blackballed. And the Ford mutiny might set a precedent for other pit traders, who may simply refuse to do business with other firms that win the right to the designated prime market-maker, or DPM, posts. Among the most sought-after posts are those trading the options of

Dell

(DELL) - Get Report

and

Microsoft

(MSFT) - Get Report

.

Plus, the scandal has thrown a wrench into the feverish work of the CBOE, the world's largest options exchange, which is racing to change over from an old way of trading options to a new method. Under the new DPM system, more than 175 candidates applied for 69 trading pit posts. The selection process continues.

The CBOE lit upon the DPM system as a way to compete with the upstart, lower-cost electronic networks; with DPMs, Wall Street firms will deal with just one group, rather than many individual market makers.

But, as in politics, the criteria for winning "in many cases is perception," said one trader at a Chicago-based options firm. The job of the DPM is to make a liquid market in options, and the firm awarded the DPM by the exchange's selection committee is expected to provide good prices, smooth execution and enough capital to back trades that might unexpectedly go bad.

As is also Wall Street's bent, image plays a strong part in creating reality. A market maker with experienced traders and a large pile of money behind it breeds business. But, as is also often the case on the Street, old relationships die hard in the face of change.

Last week, the CBOE selection committee awarded the Ford DPM to Prime Markets, considered something of an outsider. Upset that a fresh face had been awarded the Ford trading rights, traders rebelled. "The traders in the crowd don't want to do business with the new guy. So they simply didn't," said one longtime options veteran and an original member of the CBOE.

However, the veteran warned that traders "are being naive." He offered, "They're going to have to work with him because the process has to move ahead." The CBOE selection committee is meeting again today to decide what to do with the situation, according to a member of the committee.

The Ford blackball came as a surprise. Ford options had already been dually listed on both the CBOE and the

Philadelphia Exchange

(many options are listed on just one exchange), and the new DPM system is generally considered preferable for options traded on several exchanges.

Jeff Melgardi, a partner in the firm that set up Prime Markets, called any boycott shortsighted since volume already is going to the Philly.

In the rest of the options market, volume was light despite the overall indices posting some strong runs. Call-buying seemed to continue to come back into favor as the put/call ratio dropped, indicating heightened activity on the call side.

"Despite the

PPI

numbers coming in better than expected, I think people are still going to wait for the

Fed

before taking anything on," said Scott Fullman, chief options strategist for

Swiss American Securities

.

Away from the action in the usual tech heavyweights, investors were playing with the options of merger partners

Global Crossing

(GBLX)

and

Frontier

(FRO) - Get Report

, although the impending marriage is reported to be rocky.

Heaviest were Global's out-of-the-money August 35 calls, which traded 5,365 contracts against open interest of only 1,057 contracts. The August 35s moved between 7/16 and 9/16, or between $43.75 and $56.25 per contract.

The move may have been a cheap play on the possibility of Global's stock rising on good merger news, Fullman said. The strategy was an inexpensive bet because the calls were $2 out of the money with only one week left before expiration. Global's stock was up to 33, climbing 1 9/16, today. "But I don't like playing that short-term stuff," he added.

Staff Reporter

Gregg Wirth contributed to this story.