ISE … The Indexer

June 09, 2005

The options exchange innovator gets into the indexing game … and steps on a few toes in the process.

In the five short years since its launch, the International Securities Exchange (ISE) has revolutionized the options business.  Whereas trades used to be executed by individuals standing on trading floors in funny-looking suits, today most trades stream through electronic networks at amazing speeds.  In the past, a company's options were listed exclusively on one exchange; today, most options are listed at multiple exchanges, and the increased competition has led to tighter spreads and better prices. 

The ISE's own Web site makes this bold claim about the company's impact: "ISE changed the fundamental nature of US options trading."

It's not hyperbole.

ISE's success derives from a core insight: Options markets should be open, electronic, competitive and efficient.  That mantra has taken on an almost unstoppable force, with more and more volumen moving onto electronic networks.  ISE has benefitted mightily from this trend, rising from nothing to have the largest volume share of any of the six major exchanges.  But ISE's open revolution has benefited everyone else as well: Options volume has exploded industry-wide since 2000, and exchanges are more profitable than ever.

Now, ISE has set its sites on yet another corner of the lucrative options market: Developing proprietary indexes and related options contracts.  Earlier this week, ISE launched options on five proprietary sector indexes, covering everything from companies involved in homeland security to the semiconductor industry. On the face of it, the strategy marks a curious turn for ISE, because proprietary index options - by definition - trade on only one exchange.

But according to some competitors, ISE's "proprietary" indexes are anything but proprietary.  In fact, some say that ISE's indexes are derivative products that mimic other indexes already available on the market; that they are not innovative, but copycats; not unique, but generic.  At least one lawsuit has already hit the books.

And without passing judgement on the validity of the lawsuits (at least not yet), it's easy to see how the accusations - if true - would fit perfectly into ISE's general philosophy of openness and the push for low-cost, competitive markets.  Like generic drugs, these "generic indexes" would lower the cost of using the indexes, and would increase competition in the industry.  Of course, ISE would never admit to that, but it's an idea worth considering.

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