March 20 (Bloomberg) -- A test program that quotes prices for 13 classes of options in pennies may be expanded by regulators to include more contracts and spur U.S. exchanges to cut transaction fees.

Since February, about 17 percent of the roughly 10 million contracts that change hands daily have been quoted in 1-cent increments instead of nickels and dimes. Before the U.S. Securities and Exchange Commission started the six-month trial, exchanges and brokerages expressed concern that a flood of quotes would overwhelm their computer systems.

Although the number of quotes in some penny-priced contracts has more than doubled, the test hasn't disrupted trading at the six exchanges, said David Krell, chief executive officer of International Securities Exchanges Holdings Inc. The difference between bids and offers in the penny-priced options has also dropped, lowering transaction costs for investors and reducing profit for some traders.

``Margins are going to be compressed throughout the industry,'' said Peter Bottini, executive vice president of trading at OptionsXpress Holdings Inc., a Chicago-based online brokerage. ``Exchanges will have to charge less, rebates for orders will be less, and market makers will make less. But the volume should more than compensate for that.''

The SEC plans to consider expanding the penny program to other contracts by July based on trading data and recommendations from the exchanges. John Nester, a spokesman for the agency, declined to comment.

`Received Well'

The program currently includes contracts on shares of General Electric Co., the world's second-largest company by market value, Microsoft Corp., the biggest software maker, and the Nasdaq-100 Trust, a publicly traded investment fund with $17 billion. Options are the right, without the obligation, to buy or sell assets at a set price by a certain date.

``It's been received well; I don't see a reason why the SEC couldn't choose to extend'' the pilot, said Krell, head of the No. 2 options market by contracts traded behind the Chicago Board Options Exchange.

In some series of the penny-priced options the difference between bids and offers has narrowed by half, reducing costs for investors, said Scott Morris, head of the Boston Options Exchange, the smallest in the U.S.

``We'll be suggesting that they expand the pilot in an orderly process with some kind of rollout over the next 12 to 18 months,'' Morris said. ``Capacity hasn't been an issue.''

Exchanges Cut Fees

The Boston exchange cut trading fees by 25 percent this year, while the fourth-ranked NYSE Group Inc. started paying a rebate to entice market makers to send orders that set the best price for penny-priced contracts. Competition will also increase later this year as Nasdaq Stock Market Inc. expands from equities into options.

``It's going to be harder and harder for exchanges to distinguish themselves,'' said Sandy Frucher, CEO of the Philadelphia Stock Exchange, the third largest. ``The system is crying out for a restructuring.''

The exchanges have started by reducing the amount of money brokers receive for sending orders. For penny-priced classes, the Philadelphia exchange and its two larger rivals cut the fees they collect from market makers by as much as 64 percent, regulatory filings show. In 2001, the New York Stock Exchange's move to quoting equity prices in pennies contributed to a 42 percent drop in after-tax profit at the specialist firms responsible for matching buyers and sellers.

Make Traders Pay

``The guys who have been carrying the cost of the exchange are the liquidity providers, but as market-making margins are under pressure, we are under a lot of pressure to re-examine the economics of the exchange,'' said Edward Tilly, vice chairman of the Chicago Board Options Exchange. Payment for order flow is ``the first lever you'll see us adjusting,'' he said.

The CBOE is considering whether to follow an ISE proposal to impose transaction fees on customers who trade frequently, said Tilly. The CBOE eliminated customer fees six years ago to fend off competition from the ISE. ``We don't have anything filed yet, but we're watching this one closely,'' he said.

Other exchanges say it's too early to tell whether they have to adjust trading fees. The Boston exchange failed to gain market share in February after its price cuts, while NYSE Group's slice of trading slipped 0.8 percentage point to 11.6 percent, according to the Options Clearing Corp., which guarantees all U.S. options trades.

``We need to see more data before we start to re-write all the rules,'' said Neal Wolkoff, CEO of the American Stock Exchange. ``It's very early in the pilot.''

For investors, quoting prices for options in pennies offers a long overdue reduction in trading costs, said Robert Whaley, a finance professor at Vanderbilt University, who developed the Chicago Board Options Exchange's SPX Volatility Index.

``This is really healthy,'' said Whaley, who has traded options for two decades. ``I like to get in and out quickly, and that spread has been a concern for me. Based upon these numbers, I would conjecture that this pilot program is going to be a phenomenal success.''

To contact the reporter on this story: Edgar Ortega in New York at ebarrales@bloomberg.net.

Last Updated: March 20, 2007 17:17 EDT