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Merger Could Warm Exchanges' Seats

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A different options play.

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Following a report from Crain's Chicago Business that the Chicago Mercantile Exchange (CME) and the Chicago Board of Options Exchange (CBOE) were in "informal" talks of merging a seat on the CBOE, it declared that membership sold for $2.8 million on Monday. This is a 16% increase from the prior sale three weeks ago and just shy of the $3 million high recorded in early 2008.

If the $5 billion price tag being bandied about is in the ballpark of a deal, that would translate into $4 million per seat or another 60% increase from current prices.

Actually, ownership of said seats has proved to be one of the better investments over the past few years as prices have increased 10-fold since their 2004 nadir and have more than doubled over the past two years. That compares favorably to the stock prices of the exchanges that did manage to go public, which have generally moved lower, such as the CME, which is around $310 and about 50% below its 2007 peak.

As low interest rates have encouraged -- some would say co-coerced -- investors into riskier and alternative asset classes, the purchase of a seat on the CBOE might still prove to be a good investment. In fact, several money managers, such as Caldwell Investment Management, which owns 49 seats, still see value in the CBOE.

Note that this asset can generate cash flow as the seat can be leased to a third party. The current rate is around $6,000 a month or a little over 2% per year based on the last sale price. Not a lot, but better than a money market or gold.

Outside the Money Pit

When cross-town rival CME became the first US exchange to go public in 2002, it marked a major transition in the industry. Over the next few years, exchanges -- such as the NASDAQ, the New York Stock Exchange, which combined with Euronext, the International Securities Exchange, which was gobbled up by the Deutsche-Bourse, and the Chicago Board of Trade (CBOT), which ultimately merged with the CME -- all had initial public offerings that were initially great successes with shares jumping 30% to 50% on the first day and posting more than 100% gains in the ensuing years as the bull market led to growth in trading volume across a host of products.

But while the members of these other exchanges monetized their holdings, the CBOE crew could only watch in envy as it was left in the awkward position of not being able to accurately calculate the number of shares that would be rewarded to each membership stake to the exercise rights to trade held by CBOT members. If it couldn't join the party, it would at least try to capitalize by reporting on it, and in 2006 the CBOE created the Exchange Index to track this group of highflyers. Needless to say, this product never really took off, and trading in the options that are based on it is nonexistent with no current open interest.

Judgment Day

The quests for independence and to demutualize, which have slogged along for years, may finally be realized as the parties (read CBOT members) that have filed appeals against a 2008 settlement decision must submit their final briefs by Thursday.

The timing of the talks between the CME and the CBOE makes sense as would the combination. In fact it would be a nice ironic ending to the four-year odyssey that has had all the intrigue of a Greek tragedy and behind-the-scenes deal making of Chicago politics. You see the CBOE was born from the CBOT and in the structure of its formation, which granted CBOT members seats and trading rights to the CBOE, lay the seeds of its frustration.

If after years of trying to gain its independence the CBOE is folded back into the CME Group, it would make for one nice happy family -- Chicago style.

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No positions in stocks mentioned.

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