UPDATE 6-CBOE dark for much of day due to software glitch

Fri Apr 26, 2013 4:53am BST

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* Latest in string of tech-related problems in U.S. markets

* Outage meant no access to CBOE options on S&P 500, VIX

* CBOE opened all options trading at 1 p.m. EDT (1700 GMT

* Traders took opportunity for long lunches (Updates with CBOE CEO not commenting during speech)

By Doris Frankel and Ann Saphir

CHICAGO/SAN FRANCISCO, April 25 (Reuters) - A software glitch shut down the Chicago Board Options Exchange for half the day on Thursday, preventing trading in options on two of the U.S. stock market's most closely watched indexes and delivering the latest blow to confidence in the way U.S. financial markets operate.

Coming just days after hackers attacked the website of stock broker Charles Schwab Corp and a false news report on the Associated Press's Twitter account sent the stock market into a brief but steep tailspin, the incident brought attention to how technological troubles can roil the markets.

The systems outage at CBOE, which the exchange said was "in no way related to a cyber-attack," comes as U.S. securities regulators are contemplating new rules that would require exchanges to have testing and backup systems in place to deal with technological errors or natural disasters.

"As more and more of these events happen, it does hurt confidence," said Giri Cherukuri, head trader at OakBrook Investments LLC in Lisle, Illinois. "Exchanges are going to be more vigilant about how their systems are structured and that there are safeguards and backup systems."

These events have shaken investors' confidence about whether markets can be fair and orderly given how dominated they now are by complex, computer-driven systems.

Taken together, the rash of recent incidents means "you have the individual and now institutional side both affected by disruptions," said Justin Walters, co-founder of Bespoke Investment Group. "Technology can continue to advance, but I think this does show how our market structure is vulnerable, to some degree."

The CBOE, run by CBOE Holdings Inc, sought to draw a line between its problems and recent hacking incidents, blaming "an internal systems issue" and not "outside influence" for the three-and-a-half-hour closure.

In a memo to clients, CBOE chief executive Bill Brodsky and other top executives expressed regret for the outage, and said they have "isolated the software issue that caused the problem and have made the necessary adjustments for a normal opening" on Friday. The exchange is conducting a review to make sure there is no recurrence, they said.

The failure also raised new questions about the Chicago exchange's hold on options trading in two of the most closely watched instruments in the financial markets, the Standard & Poor's 500 Index and the CBOE Volatility Index.

The contracts are used by institutional and retail investors to bet on and hedge against swings in the overall U.S. stock market.

"This is a big damage to the options industry because the SPX is such a significant product," said J.J. Kinahan, chief strategist for TD Ameritrade, speaking at an options industry conference in Las Vegas attended by CBOE's Brodsky and hundreds of other market participants. CBOE's shutdown was the talk of the meeting.

"It is a wake-up call for individual exchanges to ramp up their technical systems, and even before the regulators," Kinahan added.

The U.S. Securities and Exchange Commission said its staff became aware of the situation just before the opening Thursday morning and monitored developments throughout the day.

"CBOE has determined that this was an internal systems issue. The Commission staff will continue to consult closely with the CBOE to understand the precise reason for the trading interruption and remediation measures. The Commission will continue to focus on market technology," said SEC spokesman John Nester.

GAME OF MONOPOLY

CBOE has for years successfully fought off attempts by rival exchanges to offer its proprietary - and lucrative - stock-index options, winning court backing for its right to list them exclusively. One rival lost no time in pressing the point.

"This situation brings up a great argument why the regulators should be concerned about single-listed products," said Ed Boyle, senior vice president of strategy at the BOX Options Exchange on the sidelines of the Las Vegas conference.

The incident got a lot of attention from those attending the annual Options Industry Council conference in Las Vegas. "I woke up and saw all these emails and at breakfast, everyone was just checking their phones, asking, 'What happened at CBOE?'" said Steven Crutchfield, head of U.S. options at NYSE Euronext .

When approached by a Reuters reporter at the conference, CBOE's Brodsky, who is retiring in May, declined to comment. He also did not mention the incident during his speech at a gala dinner at the conference.

CBOE licenses on S&P 500 Index and VIX options prevent the contracts being offered on other exchanges. Illinois courts have upheld the CBOE's monopoly against past challenges from competitors.

But the legal system may not have had its final say in the matter: Citadel LLC, a large Chicago-based hedge fund and one of the biggest market makers in U.S. options, has asked the U.S. Supreme Court to decide the dispute over CBOE's right to list the stock-index options exclusively.

More than 50 million of these exclusive contracts - by far CBOE's most lucrative products - changed hands at the CBOE in March.

"The perception is not great, given the intensity with which they fought to keep S&P 500 options as an exclusive listing," said Jared Woodard, principal at Condor Options, an options research and advisory firm based in Forest, Virginia.

Still, other market participants said traders and investors had alternatives to the exclusive CBOE contracts that enabled them to execute their strategies.

Trading on 10 other U.S. options exchanges continued unimpeded, and traders wanting to hedge positions in the S&P 500 could use options on the main S&P-tracking exchange traded fund, the SPDR S&P 500 Trust. Several strike prices of the SPY were the top-traded contracts on the day.

"There is no shortage of other venues to trade on," said Steve Sosnick, equity risk manager at Timber Hill, a division of Interactive Brokers Group. CBOE handles less than 20 percent of all options on individual stocks on a normal day.

Traders at the Chicago options exchange appeared only mildly put out.

Mark Wolicki, a 38-year-old trader for Zydeco Asset Partners, said he took the opportunity to go out for lunch at a nearby burger-joint and rushed back when CBOE announced markets would reopen.

"It was annoying but that's about it," said one trader, who declined to be named. Another complained about lost business. "There was nothing to do," he said, striking the pose of a man waiting around.

The Chicago exchange is the oldest U.S. options market. Most trading of options on individual stocks takes place via computer screen, but dozens of open-outcry traders crowd the areas of the CBOE floor dedicated to CBOE's exclusive stock-index options.

The SEC proposed new rules last month following a string of high-profile issues in 2012, from Nasdaq OMX's botched handling of Facebook's initial public offering and Knight Capital's near-collapse from a trading glitch to the shutdown of the public markets during Hurricane Sandy. [ID: nL1N0BZEPA].

The SEC's proposal, if adopted, would replace a long-time voluntary standard known as "automation review policies," or ARP. In replacing voluntary guidelines with rules, it means the SEC would be able to take enforcement action against violators.

This week's incidents make investors feel not only less confident about the market but that there is not always a level playing field for them, said Rick Meckler, president of hedge fund LibertyView Capital Management LLC in Jersey City, New Jersey.

"It's unfortunately a byproduct of a continued move toward electronic activity where's there's not real human intervention," said Meckler. "For the individual investor it is a problem. They don't understand these flash crashes, they don't understand systems going down." (Additional reporting by Sarah N. Lynch and Rachelle Younglai in Washington, Jennifer Ablan Herb Lash and Caroline Valetkevitch in New York, Tom Polansek in Chicago, and Angela Moon in Las Vegas.; Writing by Ann Saphir; Editing by Alden Bentley, Andrew Hay, Bob Burgdorfer, Dan Grebler and Paul Simao)

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