From the January 01, 2010 issue of Futures Magazine • Subscribe!

CBOE settles exercise right settlement appeal

The last link in the complex interconnected relationship between the Chicago Board Options Exchange (CBOE) and Chicago Board of Trade (CBOT) was finally severed and the path to a demutualized CBOE with all that entails is finally clear after the last obstacle — a final appeal to the exercise rights settlement between CBOE and CBOT members — was knocked down on Nov. 30 with a settlement of the appeal. The Delaware Supreme Court dismissed all appeals a week later.

Speculation on what it all means — including a possible unification of sorts with the CBOT through CME Group — kicked into high gear after the announcement.

On Dec. 10 the board of directors of CBOE approved a plan to pursue an initial public offering, which it intends to accomplish concurrently with its demutualization. The board set an aggressive target of the end of June for the move that must be approved by membership.

While an IPO has greatly been anticipated by CBOE members, one member told us, “[Some members] would prefer to be bought out
right away.”

He says an acquisition would allow members to monetize their ownership in the CBOE through cash and shares of the acquirer immediately whereas an IPO would probably restrict sales of the stock in steps for up to 18 months as was done with CME and CBOT. He also notes that there is a large professional investor class holding CBOE memberships who would prefer a buyout.

One sticking point could be that the current plan would only award members common stock and require them to lease trading permits from the exchange. “Some people think we should keep our trading right,” says the member.

In early 2009, a $300 million settlement was reached between former CBOT members and CBOE, which ended the dispute over exercise right privileges. In the latest settlement CBOE will pay the appealing parties of that previous settlement $4.17 million, CME Group will reimburse CBOE half the settlement cost.

“The CBOE’s going to move quickly to an IPO so they have an established valuation so any interested suitors will know any price they have to pay for acquiring CBOE,” says Peter Bottini, executive vice president of trading at optionsXpress.

Richard Repetto, principal at Sandler O’Neill, says, “If [CBOE] were to demutualize, management’s mandate would be to create shareholder value so there could be some other changes that haven’t been made because [they] catered to the membership.” He says that demutualization also will mean paying access fees to trade on CBOE.

CBOE may be better prepared than other exchanges that made the jump, because in January 2006 it streamlined its operating budget and reconstituted its committees to reflect those of a for-profit enterprise. When they made those changes in anticipation of this day, they probably didn’t envision it coming nearly four years later.

Bottini says that CME Group is the most likely suitor as NYSE and Nasdaq already have an options presence. “Politically, the mayor of Chicago has a lot of interest in these two institutions getting together to create a stronghold for the derivatives space in Chicago,” Bottini says. He adds that the biggest challenge for a marriage between CME Group and CBOE is the regulatory environment. “CME Group exists on the futures side where the CFTC takes a more hands-off approach, and they probably would not want to be subject to some of the SEC regulation that exists on the CBOE side.”

The value of the exchange based on seat value is roughly $3.2 billion if you use the midpoint of the most recent bid/ask spread ($2.65 million by $3 million) times 930 members representing 82% of the total value (18% was awarded to former ERP holders). The figure of $5 billion, which has been reported, was based on a number used by both the CBOE and lawyers for CBOT members in negotiations over exercise rights, according to sources.

Mark Longo of TheOptionsInsider says CBOE makes an excellent complement to CME Group. “If you look at CME Group on a pie chart, there is a significant piece missing. That piece lies within the equity and index options space. The CBOE fits that gap perfectly. The decline in CME Group’s stock price complicates any acquisition plans, but a CBOE acquisition would make CME Group an instant leader in the options space.”

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