VIX and S&P 500 Gems Keep CBOE Ahead Despite Nasdaq’s Big Leap

  • Nasdaq to become largest U.S. options exchange with ISE deal
  • CBOE has lucrative business trading S&P 500, VIX contracts

The Chicago Board Options Exchange is poised to lose the market-share lead in an industry it created in the 1970s, but its executives probably aren’t losing much sleep.

When Nasdaq Inc. completes a March deal to buy three exchanges from Deutsche Boerse AG, it will control almost 40 percent of options trading in the U.S. That will surpass the 25 percent share of CBOE Holdings Inc., which runs two exchanges.

Fierce price competition among exchanges has made most options trading less lucrative. Anyone who wants to buy or sell Apple Inc. contracts, for instance, has 14 markets they can turn to. Only CBOE has built a moat: No one else can offer contracts on the Standard & Poor’s 500 Index and the VIX, a CBOE measure of investor fear, and those exclusives make up more than 80 percent of the fees it gets from transactions.

“We’re playing a different game,” Edward Tilly, CBOE’s chief executive officer, said Thursday in an interview at the Options Industry Conference just outside Los Angeles. “It’s a fun game.”

While Nasdaq is paying $1.1 billion for Deutsche Boerse’s International Securities Exchange business to expand its market share by about 14 percentage points, CBOE is worth almost five times more.

CBOE’s ownership of the industry’s jewels has made it a speculated takeover target over the years, though no offers ever emerged publicly. “I’ve heard the same rumors,” Tilly said.

While nothing has come from the chatter, the company doesn’t rule out a deal one day if it sufficiently rewarded shareholders. CBOE’s shares have rallied 130 percent since the company’s June 2010 initial public offering, topping the 47 percent gain for a Bloomberg index of 28 exchange operators.

“We keep doing things right, and the industry still finds utility in our products,” Tilly said. “So we’re going to stay down that path. One day it ends in M&A, OK.”

Deutsche Boerse has given up the fight in U.S. options. The German exchange giant bought ISE, the market operator it’s selling to Nasdaq, in 2007 for $2.8 billion.

“Whilst I am sure that there were good reasons for the ISE acquisition at the time, the world has changed: the U.S. equity options market has turned out to be a place that is crowded by too many providers,” Deutsche Boerse CEO Carsten Kengeter said this week. There are 14 American options exchanges, and at least one more is planned.

For Nasdaq, buying ISE boosts its market share and doubles its ownership of the options market’s backstop, Options Clearing Corp., to 40 percent.

Nasdaq’s planned purchase is a big bet on the future of the U.S. options business, which is facing challenges. Volume has stagnated and market makers have left the business amid rising technology and regulatory costs, spurring concern that prices aren’t as good as they could be.

CBOE is alone in its ability to lean on exclusive products that have proven popular with investors. Proprietary products helped boost CBOE’s average revenue per contract traded to 33 cents last year; for indexes like the S&P 500 and VIX it was even higher, 71 cents. Over the same period Nasdaq received 16 cents per contract traded.

CBOE, which started trading about 43 years ago, won’t be losing its exclusive rights soon. It controls the VIX, officially called the Chicago Board Options Exchange Volatility Index, which was introduced more than two decades ago. The company has an exclusive license to trade options on the S&P 500 through the end of 2032, it said in its latest annual report.

Rivals have tried in the past -- and continue to try -- to break into the lucrative volatility index options business. Bats Global Markets Inc. is the latest. Earlier this year, it announced its own volatility benchmark to compete with the VIX, though as yet no derivatives trade off the product.

Supplanting the VIX won’t be easy. Getting the details correct on a contract is critical and then getting traders to participate and make the market liquid is a challenge, said Dale Rosenthal, a clinical assistant professor of finance at the University of Illinois at Chicago.

“Those are real obstacles to overcome,” Rosenthal said.

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