Stock Option Pricing
Competition Among Options Exchanges Is Good For Us
By Frank Kneipher
Dec 8, 2006 - 1:36:00 AM

In November, the International Securities Exchange (ISE) stepped up its effort to end exclusive index licensing deals.  They filed a complaint seeking permission to trade Dow Jones and Standard & Poor?s index options. This move comes after four years of nothing being done on the issue by the Securities and Exchange Commission.

Immediately after, the Chicago Board Options Exchange (CBOE) along with Standard & Poor?s parent company McGraw-Hill, and Dow Jones sued the ISE to stop the exchange from any unlicensed listing of the contracts.  The CBOE is currently the only exchange allowed to trade S&P and Dow Jones options.  The issue is whether exchanges and index providers such as S&P and Dow have the right to maintain exclusive licenses on the S&P 500 index options (SPX), S&P 100 index options (OEX), and the Dow Jones Industrial Average index options.

As mentioned here several times, the BID/ASK SPREADS can be obscene when the OPTIONS are only traded through one exchange.  As OPTION STRATEGISTS we should certainly be rooting for the ISE and their executives who have long argued that exclusive licenses are bad for the markets because there is no competition among the exchanges. Competition could lead to tighter spreads and better prices for us.  On the other side, CBOE executives have argued their exchange and its index partners have pumped huge resources into the development, sales, and marketing of those index contracts for years to make them successful.  They think they should be allowed to benefit from the success.  The ISE?s court filing seeks permission to list the Dow Jones Industrial Average and S&P 500/100 index options without a licensing deal with the respective companies.  ?ISE was founded on the belief that competition among Exchanges improves market efficiency and, ultimately, benefits investors,? says David Krell, ISE?s president and chief executive officer. ?We have witnessed this occurrence for equity, ETF, and certain index options since ISE announced its entry into the market eight years ago, providing the spark that ended the practice of exclusively listing options on only one exchange.

The ISE was able to work its way into listing ETF options on the DIA (Dow Jones Industrials) and the SPY (S&P 500) without licensing deals.  Dow Jones and McGraw-Hill filed a restraining order against the ISE to stop the listing.  This led to a legal battle where the ISE won in September 2005.  The ISE signed a temporary licensing deal with the S&P to list SPY options in January 2005.

As OPTION STRATEGIST?s this case certainly concerns us, but we are not alone as the other U.S. options exchanges will be watching the situation closely. A ruling in favor of the ISE would likely open up the index options for other exchanges to list, not to mention the smaller ranges we will see in the BID/ASK SPREADS.