Immediate Seating, Low Cover Charge
By ELIZABETH REED SMITH
March 17, 2002

The value of seats on the nation's options exchanges has been plunging. Traders who paid as much as $19,500 a month
to do business on the American Stock Exchange in August 2000 are now signing leases for as little as $1,500 a month.

The price declines have been distressing for people who bought the seats as investments, expecting them to appreciate. "This is a painful period we're enduring," said Paul Liang, who manages PBL Partners, a fund based in Chicago that invests in seats on options exchanges. The fund's value has plummeted to $14.7 million today from $70 million at its peak in 1999, he said.

Ownership of seats has become less desirable because of the protracted bear market, competition among exchanges, the
birth of a purely electronic market and shifts in trading practices that make options prices more transparent. But those same changes, people in the industry say, may benefit individual investors by cutting trading costs.

"It has really been a good thing for investors that the exchanges have been forced to compete," said Thomas A.Petrone, a managing director for global equity derivatives at Salomon Smith Barney in New York.

Seats once were real estate on the floor of a stock or options exchange. Today, no chair is involved, just the right to operate on the floor of an exchange. Lease prices hinge on the degree to which professional traders can turn a profit. "They are an excellent indicator of a floor's money-making ability," said Nicholas G. Gura, an options trader at the American Stock Exchange.

At the moment, lease prices seem to indicate that the business has become far less profitable for floor traders. (Because seats are leased more often than they are sold, lease prices are viewed as a better measurement of the value of a seat than actual seat prices.) On the Chicago Board Options Exchange, the largest United States options market, and on the Philadelphia Stock Exchange, lease prices have fallen by more than 50 percent in the last two years. On the Pacific Stock Exchange, a glut of unfilled seats has depressed their value to the point that there are no leases as such - just the $750 monthly membership fee
that owners are passing on to any takers.

Mr. Liang, 62, whose fund began buying seats in 1996, said investors in PBL Partners enjoyed annual returns of more than 20 percent in the late 1990's, when the options market was booming. In 1998, PBL Partners leased seats on the Pacific exchange for as much as $10,000 a month, he said. Now, he is among those offering them at no charge, except for the membership fee.

The fund owns 165 seats, including 60 on the Pacific exchange. Mr. Liang, who runs PBL with his son, Bart E.Liang, said the investors are wealthy individuals who put in at least $50,000 each and understand that the investment is meant for the long term.
Seat lease prices boomed with dot-com stocks in the late 1990's. Options then were wildly overvalued, Mr. Gura said, and stocks were extremely volatile. The subsequent implosion of stock prices, followed by a drop in volatility, tightened the differences between bid and asking prices, improving pricing for the retail customer, he said.

Two years ago, he said, an investor trading in options on a $40 stock might be able to sell at $6 or buy at $8, making the spread $2. Now the spread has narrowed to as little as 10 cents, he said. That translates into lost revenue for the trading intermediaries and savings for the small investor.

Rule changes in the options industry in the last three years have trimmed profit margins. Perhaps the most important was an agreement in October 1999 to end monopolies on particularly lucrative contracts.

Until then, for example, options on shares of Dell Computer (news/quote) changed hands only on the Philadelphia Stock
Exchange. Trading in options on I.B.M. (news/quote) took place only at the Chicago Board Options Exchange.

Decimalization of stock prices also helped to tighten spreads, as did the start of the International Securities Exchange, the first purely electronic options market.

The I.S.E., which opened in 2000, has lured business from traditional exchanges, forcing them to be more competitive in option-contract prices they quote to customers.

While there is general agreement that the cost of options trading has fallen, there is no consensus on whether options make sense as a financial tool for ordinary people.

Mr. Petrone says they do in some cases. A large chunk of Salomon's options business originates with retail investors, he said, though he declined to cite a specific percentage. "To the extent that people are using options in a rational way to adjust the risk- reward balance of their portfolio, they should be using options," he said.

UT Dean Leistikow, a professor of finance at the Fordham University Graduate School of Business, said ordinary investors were likely to lose money trading options. Stock options contracts, which confer the right to buy or sell an underlying stock at a preset price, expire periodically, often in less than six months. As a result, if an investor wants to hedge continuously against losses in a portfolio, she will have to take on significant, cumulative transaction costs, Professor Leistikow said. Diversifying
investments over the long term is a better way for investors to protect themselves from a blow-up in a particular stock or a market downturn, he said.

"It's a zero-sum game," he said. Based on academic studies, he said, 80 percent of the people who trade in futures or options contracts will lose money in the long run.

Whether the appeal of options to more investors will revive seat prices is unclear.

Despite the competitive forces working against the exchanges, Mr. Liang said seat prices would rebound. The I.S.E. and other electronic systems that come along will act as auxiliaries to the exchanges, rather then drive them out of business, he contended.
The price decline, he said, can be largely attributed to the turbulence of financial markets. "We've seen people getting hurt in the options market like never before, just in the last several months, because of the dot- com bust, and then Sept. 11 and then Enron (news/quote)," he said. Such difficulties are unlikely to last, he said.

In addition, he said, floor traders enjoy an edge over outsiders. They pay less to maintain trading positions and get first crack at large and therefore more profitable orders, most of which are still filled on the exchange floors.

Others say, however, that the changes are structural and reflect problems with traditional options exchanges. Arthur J. Duquette, a senior managing director at Bear, Stearns, said he doubted that seat prices would ever return to previous levels. Bear, Stearns, which owns a stake in the International Securities Exchange, has begun to route some of its business to the burgeoning electronic market, Mr. Duquette said.

Exchanges like the American Stock Exchange and the Chicago Board Options Exchange, he said, will increasingly make
money from electronic processing of trades and less from people trading on the floor, thus reducing the importance of seats. "I think these trading privileges will lose value over time because of technological innovations at the exchanges and fewer floor participants involved in the trading."