Merging Markets

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 trading floor, as the new entity chooses to focus on the more lucrative options business.

As part of the merger agreement, reached by the boards of governors of both exchanges Wednesday, the Pacific’s main options trading operation will remain in San Francisco and continue with plans to build a new facility in the city.

William J. Brodsky, chairman and chief executive of the CBOE, the world’s largest option exchange, will hold the same titles at the combined exchange.

A merger, if approved by the exchanges’ members this fall, is projected to save the exchanges as much as $80 million in the next 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. But the Pacific ranks as the third-largest options trader, 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 Pacific’s leadership decided it needed to partner.

But the deal will mean that the slower-growing stock trading operations of the Pacific--which like the handful of other regional U.S. exchanges offers institutional and individual 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 to answer questions.

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 trading floor back into their brokerage offices--creating a “virtual” exchange.

“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.

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 with one another via the Pacific’s system, and be assured anonymity.

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 stock trading unit.

Bill Lupien, chairman of OptiMark, said that although he is not worried about OptiMark’s funding level or interest from the CBOE, he admitted 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.”

Any merger must still be approved by the Pacific and CBOE members and the Securities and Exchange Commission.