Diversity and Innovation are Key Issues in NYSE/Amex Talks

Though it remains secretive about its acquisition targets, sources say the Big Board still has its eye on the Amex's ETF and equity-options product lines.

Does the New York Stock Exchange need to offer its customers a top venue for trading equity options and exchange-traded funds in order to maintain its dominance in the U.S.-financial-services landscape? That's one of the important questions the Big Board must weigh as it continues to kick around the idea of acquiring the American Stock Exchange - a diverse market that could provide the NYSE with the ability to expand and test new products.

Since grabbing headlines in early March, by admitting to preliminary merger talks, the NYSE and Amex have remained tight-lipped about their potential alliance. But sources close to both exchanges say the Big Board, which would have to purchase the Amex from the National Association of Securities Dealers, is still pondering the benefits of acquiring the Amex's equity-options and ETF product lines.

While it accounts for less than 3 percent of the listed-equities volume in the United States, the Amex is now the largest American market for ETF trading, and ranks second (to the Chicago Board Options Exchange) in U.S.-equity-options volume. What's more, the exchange plans to begin trading single-stock futures, in an open-outcry environment, later this year.

"Via the acquisition of the Amex, the NYSE would have a vehicle to experiment with new products, and new trading systems, without compromising its market," says a source close to the Big Board. By "nurturing" the Amex as a "creator of new investment vehicles," this source says, the NYSE could meet its responsibilities to innovate, without taking risks that could endanger its primary equities market.

However, while agreeing that the Amex could handle the Big Board's responsibilities to expand and innovate, a source close to the Amex says the acquisition talks have been fueled primarily by the success of the Amex's equity-options and ETF businesses. The ETF product line, he says, is particularly alluring to the NYSE, because the Big Board has only had moderate success trading the QQQ - the Amex's largest ETF contract.

"The NYSE is getting into the game ... (but) it only (accounts for) 11 or 12 percent of the QQQ volume today," says the source, while noting that the Amex now trades approximately 107 ETF contracts.

The source close to the NYSE retorts that the Big Board is happy with the progress it has made trading the QQQ - a wildly popular open-ended mutual fund that tracks the Nasdaq 100. Moreover, noting that the Island ECN overtook the Amex as the largest execution destination for QQQ trading late last year, the source says the NYSE is skeptical about whether the Amex will indeed remain the strongest ETF market. "I think Amex's argument for a merger with the NYSE would be much stronger if it had maintained a dominant position in QQQ trading," says the source. "Obviously, Island is offering people something in ETF trading that is more attractive than either the American or the New York is offering."

From Amex's perspective, the source says, a merger with the NYSE would provide one major benefit: economic stability. The Amex, notes the source, has grown its business over the last two years by expanding into new areas. But the exchange cannot continue to innovate without the proper financial backing. "There is a good economic basis for the Amex to do this (merger) because it is living on the edge today," adds the source.

Sang Lee, an analyst covering e-trading for the research and consulting firm Celent Communications, says that the Amex could also potentially benefit from listing options based on Big Board equities. "From an options perspective, the deal would enable the Amex to leverage the NYSE's equities business. So it could be a really nice combination," he says.