Trader Talk

Exchanges: Big Winner In Market Volatility


The volatility in the stock market due to concerns on a slower economy and credit market risk is creating one clear winner: exchanges. We are seeing new highs for Nasdaq and are just off new highs on the Chicago Merc and Intercontinental Exchange ; the New York Stock Exchange has gone from $70 to $90 (up 28%) in less than 2 months.

What gives? 1) volatility in the markets means higher volume means more profits for exchanges, and 2) these companies have emerged as "alternative financials", given the weakness in brokers and banks.

What's the future of the NYSE floor? A brief article in yesterday's New York Post concluded that the NYSE's Hybrid trading system--which combines electronic trading with the NYSE floor--has been unsuccessful. It's true that the NYSE's market share has been eroding, but that was an inevitable consequence of the move to electronic trading, where whatever system can provide the fastest execution wins.

Had they kept the floor and never adopted an electronic model, they almost certainly would have lost even more market share. On the flip side, it was unfeasible for the NYSE to go all-electronic in 2006; the platform was not there. Some believe the Hybrid is a transitional model to an all-electronic model, but at any rate there was little alternative to the Hybrid in 2006.

What's the alternative today? There are not many; the main one involves closing the floor and moving everything to the Archipelago electronic trading platform. There are two problems with doing this any time soon: 1) it's not clear that Arca's platform is robust enough to handle the volume of trading, though it is getting there, and 2) despite pressure from some investors, the NYSE still wants to maintain the floor, both as a way to distinguish it from its electronic competitors and for the very valuable television and print coverage that emanates from the floor.

The bigger problem is how the NYSE can distinguish itself from its competitors. Its main strategy involves the development of a global footprint that combines equities with derivatives trading. That is why they merged with Euronext (with its European equities and derivatives platform), and why they will likely buy a U.S. derivatives exchange like the Nymex. It's why they have a piece of the National Stock Exchange of India, and why they have a strategic partnership with the Tokyo Exchange.

Questions?  Comments?