Growing Popularity and 24-Hour Trading on the Way

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

CBOE Holdings, (NASDAQ: CBOE) which operates the largest options exchange in the United States, has done very well in recent years.  In fact, the company has exceeded analysts’ expectations in 8 of the last 9 quarters.  As a result, shareholders have been handsomely rewarded.  Since the “streak” of good quarters began, shares have risen from a low of $19.60 to the current level of around $34.00, a gain of over 73% in little more than two years.  With CBOE set to report earnings on Friday, I think this company has some major tricks up its sleeve to keep the growth going.

The Company

CBOE operates the Chicago Board Options Exchange, as well as C2 Options Exchange and CBOE Futures Exchange.  The company lists options on individual stocks, market indexes, and securitized baskets of assets (like ETF’s), and offers both electronic trading and trading on its floor in Chicago. 

CBOE is by far the largest options exchange in the U.S., with a market share that has hovered around 30% for the past five years now.  Among its proprietary products are S&P 500 index options, the most widely traded options on the market and the CBOE Volatility Index options, which have soared in popularity and relevance since the financial crisis as the “indicator of fear in the market.”

Options are arguably the fastest-growing aspect of the investment world, becoming more popular every day due to their exciting nature, huge profit potentials, and for their very practical use for hedging portfolios and creating income in the way of selling calls.  Just turn on CNBC or any of the other financial news sources.  It seems like options are becoming part of more and more discussions as time goes on. 

Growth

Some investors consider it a major red flag that total options volume in 2012 was down approximately 7% from the year before.  I believe this is a direct result of the recovery taking effect and less volatility in the equity markets, and not a loss of interest in options trading.  I personally think options volumes will begin to increase again as the market rises, as more equity investors will enter options contracts as a “hedge” to protect their profits.

What should really drive growth going forward are the company’s two major developments for 2013.  First, the company is opening up a new trading hub, which will greatly increase the amount of trading volume CBOE gets from European investors.

Second, and most significantly, the company plans to introduce 24 hour a day options trading for 5 days a week, beginning this year.  Up until now, Asian and European investors who wanted to hedge their bets on U.S. stocks had to do so during normal market hours.  This could be absolutely huge!  Look for the company to possibly provide more concrete details on this, especially regarding the timeframe for implementation.

Valuation and Competition

Although CBOE trades at a lofty P/E ratio of 20.6 times earnings, I believe that this is completely justified, and perhaps even a little cheap.  First off, CBOE has an excellent balance sheet, with $160 million in cash on hand and no debt, a position that most likely has improved since last quarter.  The company has an excellent buyback plan in place, and has reduced the number of shares outstanding by 13.8% in the past two years. 

Additionally, the company is projected to grow earnings rapidly over the next several years as it transitions to 24-hour trading.  Consensus estimates (which I think are a little too conservative in this case) call for earnings growth of 12.1% and 14% for the next two years, which more than justifies the multiple.

There are seven other U.S. options exchanges that CBOE competes with, including the household names NYSE Arca, which is in the process of being acquired by Intercontinental Exchange (NYSE: ICE)  and NASDAQ’s OMX PHLX (NASDAQ: NDAQ).  However, I believe that CBOE simply offers investors much more growth opportunity that either of these exchanges. 

Intercontinental Exchange trades at 18.8 times earnings, with similar earnings growth potential as CBOE.  Additionally, the company does not have a similar positive net cash position as CBOE.  ICE is a great company and a great investment; I just foresee much more growth in the options industry in the next few years.

NASDAQ, on the other hand, trades at just 14 times earnings, with 8.5% growth.  Not a bad valuation, however, the company has net debt of about $1.3 billion, which is a significant amount.  It is definitely not an unmanageable debt load, however I like investing in low-debt companies whenever possible.

To sum it up, CBOE already operates in a very dynamic and relatively new area of trading.  With the coming transition to round-the-clock options trading and an increased global presence, the sky is the limit.  More important than the earnings numbers themselves will be the company’s updates on their expansion plans and the outlook for volatility and trading volumes going forward.


KWMatt82 has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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