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'Chicago' Poker Showdown


Make no mistake about it, the leadership at the BOT is playing a very serious and high-risk game of poker with the CBOE.


"Life, like poker, has an element of risk. It shouldn't be avoided. It should be faced." -- Ed Norton

I used to play poker here in Chicago with a bunch of wealthy businessmen. We'd meet every other month and play for four or five hours, the first four would be limit and the last hour was, you guessed it, no limit!

Knock on wood, I only came home with less green once, but in that final hour I really grew to appreciate the value of bluffing. I won more hands (and more money) with a pair and a thin smile during that final hour than I did in the previous four hours. Like Kenny Rogers said, "You gotta know when to hold 'em, know when to fold 'em."

That brings me to the saga of the Chicago Board of Trade (BOT) and the Chicago Board Options Exchange (CBOE). The BOT launched the CBOE back in 1973, and each of the 1,481 full members at the CBOT was given the right to trade on the CBOE, effectively increasing the CBOE from 931 memberships to 2,412.

This held down the value of the CBOE membership, but made access for traders the bargain of the industry. (Just for full disclosure, through an investment trust, I own seats on the CBOT, CBOE and NYSE.)

The CBOE members, however, resented the dilution that those 1,481 full members of the CBOT represented, so talks to retire this so-called "trading right" began to gather steam. When the CBOT offered its shares to the investing public in the fourth quarter of 2005, talks to extinguish the trading right stalled, as the CBOE contended that the IPO ended their obligation to provide access to members of the CBOT.

As the CBOE accelerated its plans for its demutualization (through the IPO), though, the talks resumed. However, on Wednesday (Aug. 23), the talks broke down and, within hours, the CBOT sued in an attempt to hold on to its trading rights.

Now here's where things get interesting. As with any IPO, there is a so-called lockup period for CBOT members, which keeps them from dumping shares into the market. Members of the CBOT first were able to sell 1/3 of their shares on April 22, 2006, and shares were hit by about 3.4% immediately. The reason? Members owned 93% of the 53 million shares outstanding and many were chafing at the bit to unload shares and take some profits. The next date for another third to become free to sell (unlocked) is Oct. 13, which has shareholders nervous.

The CBOT members, who hold the overwhelming majority of shares of the NYSE-listed CBOT, have been held back from selling by those lockup agreements and the fear that their sale of CBOT shares could result in the loss of their trading right on the CBOE -- a right that traded last week for $135,000. And that's what makes me use a poker analogy.

Prior to the break-off of talks with the CBOE, CBOT shares were trading for $119 apiece. The CBOT has slipped below $111, and that 6.7% drop reflects two things:

1) The potential that a judge rules the CBOT has indeed already lost its trading rights on the CBOE.

2) The P/E the BOT trades for is even higher than that of the world's largest futures exchange, the Chicago Mercantile Exchange (CME). The CME trades at a 44 P/E, while even after its recent slip, the BOT's P/E is 49.

Make no mistake about it, the leadership at the CBOT is playing a very serious and high-risk game of poker with the CBOE. The lockups are coming off and soon the only thing holding back sales of CBOT stock is the threat of the loss of trading rights on the CBOE.

CBOT members have been loath to extinguish those rights, but if it looks like a judge could rule against them, it might have the same effect as yelling "FIRE!" in a crowded theater. The CBOE has priced in the dilution of their memberships, but the CBOT has not. The threat of losing that trading right, along with the CBOT's hefty P/E, could mean some difficult days as that October lockup looms!
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