Pacific Exchange and CBOE Agree to Merge Options Business

Confirming weeks of speculation, the Pacific Exchange and the Chicago Board Options Exchange said Thursday they have agreed to combine into one market that will handle the bulk of the nation’s trading in stock option contracts.

And, as expected, the deal puts in jeopardy the future of the Pacific’s downtown Los Angeles stock-trading floor, as the new entity chooses to focus on the more lucrative options business.

As part of the merger pact, reached by the exchanges’ governors Wednesday, the Pacific’s main options-trading operation will stay in San Francisco and continue with plans to build a new facility there.

William J. Brodsky, chief of the 25-year-old CBOE, the world’s largest options exchange, will run the combined exchange.

A merger, which still must be approved by the exchanges’ member firms, is projected to save the exchanges as much as $80 million over five years, mostly by avoiding the duplicative cost of developing new high-tech trading systems.

Options trading, which allows investors to make significant bets on stocks’ direction with relatively little money down, has been a fast-growing business in the 1990s. The Pacific ranks as the third-largest options trader, far behind the CBOE and the American Stock Exchange.

As U.S. securities markets have increasingly sought to join forces to gain critical mass and reduce costs, the 116-year-old Pacific--which traces its roots back to the Gold Rush--decided it needed to partner.

But the deal will mean that the slower-growing stock trading operation of the Pacific--which like the handful of other regional U.S. exchanges offers investors a competing market to the New York Stock Exchange--will probably be spun off in the next 18 months. The stock exchange could eventually join with another market or a technology company, sources said.

“We’re not closing anything down tomorrow,” said Robert M. Greber, chairman of the Pacific, who will depart once the merger is complete. “We’re going to find a solution along with our equity members. The long-term goal of the CBOE is not to have the stock trading business. But we have plenty of time.”

Still, some of the exchange’s “specialists”--the traders who stand by ready to buy or sell stocks in the companies they follow--are worried about their future.

“This could be a very good thing, but there remains a significant amount of concern about what will happen to the equity members,” said Jonathan Werts, president of the San Francisco Specialist Assn., which represents about 38 traders. “We’re concerned about the lack of representation here. We don’t seem to come out of this deal with a whole lot going forward.”

Greber and other key members of the Pacific--which splits its stock trading business about 50-50 between its San Francisco and Los Angeles floors--met with members in both cities on Thursday.

The Pacific’s stock trading floor in Los Angeles employs a staff of about 100, plus about 50 specialists. Several sources predicted it could be closed by the time the lease is up in 2001, and the specialists moved from the floor back into their brokerage offices--creating a “virtual” exchange without a physical location.

The Cincinnati Stock Exchange already is such a virtual market.

“In Los Angeles, our members will tell you we don’t need all that space,” said Greber. “If all our equity members could operate in cyberspace, it would be much more cost-effective.”

But another source speculated that given the amount of space the Pacific has in Los Angeles, if the equity trading unit finds a partner that wants a physical floor, all the equity business could eventually be consolidated in Los Angeles.

Meanwhile, Greber reiterated strong support for a new all-electronic trading system devised by OptiMark Technologies. Slated to start in September, OptiMark is designed to allow big investors to trade directly with one another via the Pacific’s system.

OptiMark’s level of success could be the deciding factor in another company’s or stock exchange’s decision to partner with the Pacific’s orphaned stock trading unit.

Bill Lupien, OptiMark’s chief, said that although he is not worried about OptiMark’s funding level or interest from the CBOE, there is some uncertainty about the future. Lupien said he might put a group together to buy the Pacific’s equity business. “I will not allow the equity business to go away,” he said. “That would be a crime.”

The merger announcement follows the Nasdaq Stock Market’s recent acquisition of the American Stock Exchange and the Philadelphia Stock Exchange.