Many of the futures commission merchants favour a model for the US futures business that is suspiciously similar to that employed in the US options market. It’s a model, conversely, that the futures exchanges are keen to avoid, as they have seen what effect it has had on the Chicago Board Options Exchange.
The CBOE is suffering from a substantial drop in volume. Brokers are leaving the pits to trade electronically upstairs either for their own account or for customers, often becoming price takers rather than market makers, as they used to be on the floor. Electronic rivals are snapping at the exchange’s heels. Its technology platform needs updating. The price of a member’s seat has plummeted to less than one-third of its peak just a few years ago. And now there are complaints about the leadership, with some suggesting that it’s time for the chief executive to go.
“We’ve been having our own share of political problems here of late,” admits Bill Brodsky, who has been chairman and chief executive of the CBOE for nearly seven years. He’s a survivor. But he’s not understating the drop in business. “We’re in the securities business and the equities business, and that’s been in a funk,” he says. “And the exercise rights which Board of Trade members have to trade here hit our seat price.”
Full members of the CBOT can trade at the CBOE without buying a seat, and many had moved over during the equity bull run. Now a lot of them have moved back to trade the better volatility in the treasury pits across the street at the CBOT. Meanwhile others have simply moved off the floor to trade upstairs. The seat price fell below $150,000 last year, although the last transaction, in the first week of January, was for $170,000. Back in 1998 the price hit $500,000, and for a couple of years it was higher than that for a seat at the CBOT.
The CBOE is the only Chicago derivatives exchange forced to operate in a fully fungible market. What this means is simple: any entity that has been approved by the SEC to be an options exchange can list prices for products on other exchanges. Clients therefore have a choice of where to send their orders to buy and liquidate their positions according to where they find the best price, liquidity or speed – depending on whichever is most important to them.
The US options business has five competing exchanges: CBOE, Pacific Exchange/Archipelago, Amex, Philadelphia Options Exchange, and a new all-electronic offering called the International Securities Exchange, or ISE. It was set up in 1998, and funded in large part by a group of broker-dealers. A sixth, the Boston Exchange, is due to launch by the end of the year. The upshot of the fungibility rules is that the exchange with the best systems is likely to dominate market share, assuming the price is also competitive.
For now the CBOE is still the top options exchange, but a good deal of the growth of the ISE’s market share has come at the expense of the CBOE. And it didn’t take long: within 18 months of its launch in mid-2000 the ISE had come from nowhere to be the third-largest options exchange, and has a market share of around 25%. The CBOE’s share is 37%.
The Chicago exchange is fighting back, though. It is due to launch its hybrid trading system in April or May. It’s yet to be given an official name, but those working on it call it Bob. It stands for “best of both worlds”, referring to its purported ability to utilize the best of both electronic and pit trading. Some of its features are already up and running. The most important is the large-order utility system, which was introduced in mid-July and allows large orders to be traded electronically at the CBOE for the first time.
It has required what some might initially deem a backward shift in technology; the CBOE was until recently known as the most technologically progressive of the Chicago exchanges, epitomized by its adoption of wireless handhelds in the 1990s. They’re still in use, but much of the connectivity is now through a hardwire system. “It might sound like a retrograde step,” says Ed Tilley, an independent floor broker and head of the exchange’s committee for new technology developments. “But the truth is that the wireless networks aren’t able to provide the amount of bandwidth we need.”
The hardwire system also means that laptops can be used in the pits. There’s a growing number of brokers who are already using them, affording them much more efficient access to their clients, their colleagues off the exchange, or both.
Brodsky’s future at the CBOE will depend to a great extent on whether Bob the hybrid is a success. That might take no more than a few months to become apparent.
