MARKETS - Odd Man Out?

William Brodsky, Ceo of the Chicago Board Options Exchange, isn't one to dwell on what might have been. Not that he doesn't have reason to. When Chicago's two big futures exchanges agreed to merge last fall, Brodsky was left holding the bag. He had been negotiating a deal throughout the summer with the Chicago Board of Trade, the CBOE's former parent, which decided to sell out to the Chicago Mercantile Exchange for $8 billion instead. So Brodsky, the CBOE's top dog since 1997, is forging ahead with plans of his own: to expand into stock trading and to transform his member-owned cooperative into a for-profit, publicly traded company. Becoming the seventh U.S. exchange to go public would give the CBOE, the biggest of the country's six options markets, more flexibility to cut deals in an industry undergoing rapid consolidation.

"We are better suited to be an acquirer or an acquiree or a partner if we are demutualized," says Brodsky, 63, describing the process of converting membership seats into shares, a precursor to an IPO.

Brodsky, a securities lawyer and former American Stock Exchange and CME executive, is building on a solid foundation. After losing market share to the all-electronic International Securities Exchange early in the decade, the CBOE in 2003 built a hybrid trading system and today executes 96 percent of its trades automatically. Its market share rose from 31 percent in 2005 to 33 percent last year, just ahead of the ISE's 32 percent. Profits more than tripled, to $42.3 million, in 2006. Seats now trade at a record $2 million, making the CBOE worth some $1.9 billion.

Still, Brodsky just can't seem to emerge from the CBOT's shadow. In August the CBOT sued his exchange over the so-called exercise rights that its members received at the time of the CBOE spin-off 34 years ago. The CBOT argues that the rights are convertible into seats, representing 60 percent of the CBOE's equity, and wants their holders to participate equally with CBOE members when the exchange demutualizes. The CBOE asserts that the rights will be void once the CBOT is acquired by the CME. (The deal is scheduled to close by midyear, though a higher bid last month by the IntercontinentalExchange has complicated the situation.) The lawsuit, still pending in Delaware, will have to be decided or settled before any IPO by the CBOE.

Brodsky won't comment on the case except to say he's confident the CBOE's plan will go forward. Demutualizing and preparing an IPO can take several months, meaning that the exchange wouldn't be ready to go public until at least November anyway. Meantime, he is focused on the CBOE Stock Exchange, or CBSX, which launched last month. By midyear it plans to offer trading in 2,800 shares listed by the New York Stock Exchange, the Nasdaq Stock Market and the American Stock Exchange. Half-owned by four big trading firms that are supplying it with order flow, the CBSX aims to exploit rules, dubbed Regulation National Market System, that took effect March 5 and require trades to be executed at the best quoted prices regardless of venue. Reg NMS provides a huge opening for rivals of the NYSE and Nasdaq, which together handle more than 70 percent of U.S. stock trades. David Harris, who runs the CBSX, says that capturing 6 or 7 percent of stock trading in three or four years would be "a home run for us." So far the exchange has snatched about 2 percent of volume in such stocks as Anheuser-Busch Cos. and Gap. But it faces intense competition from as many as seven other markets also gunning for the NYSE and Nasdaq.

And stock exchanges are coming after the CBOE's options business just as hard. The NYSE last year bought Archipelago Holdings, whose ArcaEx system handles 13 percent of U.S. options volume. Nasdaq will launch an options exchange later this year and is shooting for 20 percent market share by 2010. Brodsky thinks the NYSE and Nasdaq may need to buy smaller rivals to challenge the CBOE and the ISE. Should that happen, a publicly traded CBOE would be ready to respond in kind. "Consolidation is inevitable," says Brodsky. "It's just hard to predict when and how."