It's been a little more than a month since
Chairman Bob Greber was jilted in his high-profile merger talks with the
Chicago Board Options Exchange
On this February morning, he's scorned but thoughtful, and talking more about his exchange's plans. Greber rattles off some numbers, including spending $2 million on a new quote system, maybe another $2 million on development of a hand-held trading terminal and untold more millions on an electronic-trading initiative.
"We have $25 million in cash reserves that we were saving for a rainy day," he says between spoons of oatmeal. "Now it's raining."
Greber's not alone in the downpour. His options-trading counterparts at the CBOE,
American Stock Exchange
Philadelphia Stock Exchange
are in much the same situation. As they slash customer fees to attract more volume, they're spending money on technology development with an attitude normally reserved for shore leave in Singapore. The impetus for this dual action: electronic trading. The options exchanges are edging away from the traditional system of traders yelling at one another on the floor and toward people simply punching buttons, enabling them to slash what they charge customers. In addition, new competitors specializing in electronic trading are on the way, which also is expected to put downward pressure on pricing.
Forget, for a moment, the
investigation into collusion among the options exchanges to keep some options listed on just one exchange and the specious litigation that has followed. Concentrate instead on what will happen to the options industry in the next nine months. Customers will pay less to trade, trading firms (market makers and specialists) will pay more to do business and spreads will contract as exchanges battle each other for the "switches" -- the speed-dial connections -- of major trading desks to win order flow. More than even before, the game is becoming one of pure volume.
The options trading chief at a major New York brokerage tries to put all this in perspective, saying the events of the next year likely will spawn a massive role reversal in the options world. "We're moving toward zero-cost execution. At some point, the market makers will pay for the order flow like any other institution," the trader says.
Adding momentum to this movement is the screen-based
International Securities Exchange
, the brainchild of electronic and discount brokerages that couldn't squeeze the exchanges into paying them to send orders their way, called payment for order flow. Beginning in 2000, the ISE will list the 600 most popular options. It threatens to be cheaper and more efficient than the floors. And as a result of its venture, order flow on singly listed options such as the CBOE's
, the Pacific's
and the Amex's
will be up for grabs among all exchanges.
The rapid response from the exchanges to slash customer fees down to the marrow levels the field. In changes announced during the past two weeks, the Amex and CBOE won't even charge customers for orders of less than 30 contracts. Transaction fees at the CBOE on other orders will fall more than 60%, to 9 cents a contract.
All this puts the competitive ball back in the hands of Bill Porter, the ISE chairman who also founded
, and David Krell, his top man. So before its machines are plugged in, the ISE is under pressure to produce more than management's lofty public goal of cutting trading costs to as much as 30% of what exchanges charge.
The 70-year-old Porter has been scoffed at before. In 1982, when he began experimenting with the idea of trading stocks via personal computers, he says, people laughed. He had only one programmer -- who was legally blind and had to view a 9-inch monitor through a magnifying glass.
This time around, though, the competition is prepared. Porter is confident that this battle can be won, much the same way he was confident in the future of online trading. "Assuming the exchanges can do this
operate profitably with such low customer fees, we're still in good shape," he says, adding that the initial order flow providers are also equity participants in ISE -- paying several million dollars each -- and have more incentive to route their options orders through ISE.
Whether those firms -- E*Trade,
Herzog Heine Geduld
-- can account for the 10% of all options volume they claim to trade is another big question. The feeling among many traders is that until the ISE lands a big fish -- an order flow producer such as
Morgan Stanley Dean Witter
or a trading firm such as Chicago's
-- it doesn't have a real chance to be a breakthrough system. One big-time trader says he overheard a high-ranking CBOE official say: "It's the second system we're worried about."
Meanwhile, Amex boss Dick Syron says the exchange's fee reductions didn't stem directly from the ISE. "This is part of a program we had planned to begin as soon as we completed the
-Amex merger. It's not a response to them
the ISE; it's a response to the world out there."
Syron, unlike his counterparts at the CBOE, Pacific, Philadelphia and the ISE, has a sugar daddy in the Nasdaq that will help make up the revenue lost from lower transaction fees. The other three will have to make their market-maker and floor-trading firms pay more to cover the gap. "One of the benefits of the association with the NASD is that we're able to take a longer-term strategic view," he says.
Adding to the competition will be the Amex ability to package equity and options products with its Nasdaq parent, which will rattle the single-listings status quo. "There are a number of things we can do with options on securities that are listed on Nasdaq," Syron says. The Pacific also may be able to leverage its
trading system with some of its options listings to create similar packages.
Maintaining market share will take this kind of creativity, especially in a low-margin, technology-driven trading environment. Most traders welcome the competition. "Someone standing still deserves to get slugged," says Tom Ascher, a former CBOE vice chairman and vice president for
, a major trading firm. "The biggest issue is delivering value. The whole venture is a reflection of something the market is looking at."
Hardened floor guys, however, think the competition will come down to the issue of liquidity, of which floors provide plenty right now because trading crowds exist to help fill customer orders.
ISE "can launch, but soon we're all gonna have markets that are a teenie wide," says one Chicago trading firm head. "Then where's their
the ISE's technology going to be?"