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It's Nice to be the Prettiest Girl at the Dance

April 11, 2007

Dear Fellow Options Trader,

With the bidding wars for both the Chicago Board of Trade and the London Stock Exchange heating up, there was bound to be some spillover into the other derivatives markets. In particular, a story appeared in today's Wall Street Journal that the Nasdaq Stock Market (NDAQ) -- whose bid to buy the London exchange didn't go through -- might now be in talks to buy the Philadelphia Stock Exchange (PHLX).

In turn, this has sparked speculative buying in shares of the International Securities Exchange (ISE). As you might know, the Philly exchange and the ISE are options-trading powerhouses, a market that the Nasdaq has indicated a strong interest in participating in.

The ISE kicked off 2007 at $46.60 and has been treading water ever since. Despite its great technology and the fact that it does not have to support a trading floor (as it's an all-electronic exchange), it's been unable to wrest back the No. 1 spot in the six-exchange competition for option-trading volume from the Chicago Board Options Exchange (CBOE).

There are several reasons the CBOE has retained its stranglehold on that coveted spot:

* The CBOE's hybrid trading platform allows folks to stream bids and offers from both the electronic world as well as via the traditional open-outcry system on its trading floor.

* The CBOE has an exclusive contract to trade options on the S&P 500 and S&P 100, as well as on Dow 30 and several other indices, effectively allowing it to own the index-option space.

* The CBOE averages 84% of all index volume transacted on a daily basis.

The thinking among trading pros has been that, if one were serious about entering and dominating the option business, they would do a deal with the CBOE, as it is the only exchange that can offer soup-to-nuts service on everything from equity options to index options.

Other exchanges -- the ISE, PHLX, Boston Options Exchange (BOX) and the American Stock Exchange (AMEX) -- can only offer equity options and a smattering of multiple-listed indices.

The New York Stock Exchange (NYX) clearly understands this, as its merger with Archipelago and takeover of the Pacific Exchange (PCX) -- the other exchange on which options can be traded -- has left it with a first-rate electronic platform that Jerry Putnam developed for stock trading. However, it has not brought a better-than-13% penetration of the market -- hardly a spot the world's-largest and most-liquid stock exchange would deem fitting for its stature in the financial industry.

If the NYX were to consider purchasing the CBOE, that would mean the NYX could add its 13% market share to the CBOE's 33% and, thus, control nearly half of all U.S. derivative business.

By the way, during today's session, our computer systems showed individual investor speculation (but not institutional speculation) that a deal would get done with the ISE. In fact, only the out-of-the-money ISE May 50 Calls (ISEEJ) traded above the previous day's open interest, and the anemic total of that open interest was a mere 479 contracts.

In other words, a deal for the ISE could get done, but very few are betting on it.


Jon "Doctor J" Najarian
Editor
ChangeWave Options Trader