| 07 December 2009

OptionsHouse announced a modified pricing plan last week that, we believe, signals more changes to come as more brokers choose to compete on value and not on price. In order to understand why we think this is likely the first in a series of chain reactions, we offer up a quick history lesson:

Charles Schwab (SCHW) may have paved the way for discount brokers but it was firms like E*TRADE (ETFC), Scottrade and Ameritrade (bought by TD) that built empires on discount pricing plans and online access. But most accounts were relatively simple and complex trades were still reserved for the phone rep.

As things developed further, however it didn't take long for the active trader market to grab everyone's attention. Not only were active traders signing up for new accounts in droves, those new accounts were, well, active. Firms like Cybertrader and thinkorswim and optionsXpress (OXPS) bridged the gap between the complex systems offered by TradeStation and eSignal and the still relatively active effort to trade options.

Recognizing the value of these accounts (smaller in number, but much more valuable for their activity) Schwab gobbled up Cybertrader and TD Ameritrade (AMTD) gobbled up thinkorswim while optionsXpress chose to go-it alone and went public.

But then a new breed of firm started cropping up. Zecco promised "free" trades (sort of). TradeMonster and TradeKing promised low flat-rates on options trades. And why? There's more to an account than just fees for trading. These firms banked a large part of their strategy on margin balances, payment for order flow, spreads and other "hidden" fees. In fact, OptionsHouse came right out and told traders that it was making money on your account in other ways, and this allowed them to slash pricing. It was a bold move.

Until now. The problem is that margin rates have collapsed and bid/ask spreads are now paper thin. We reported earlier on the beating that Interactive Brokers took last quarter. Ther EPS fell 70% mostly on tighter bid/ask spreads. In our conversation with Michael Raneri, Zecco's new CEO, he was careful to downplay any edge they may have on bottom-line pricing. “We prefer to think of ourselves as the best value in the marketplace,” he said.

Which brings us back to OptionsHouse and their new pricing plan. Instead of a flat rate of $9.95 for up to 4,000 contracts they now charge $5 for up to five contracts. Trade more than that and it's $8.50 plus $0.15 per contract. The rates increase further for complex spreads, straddles and other combo trades to $12.50 plus $0.15. This means that low-volume traders will actually pay less, but high-volume traders will pay more.

We believe OptionsHouse is adjusting ahead of the curve. They know all the back-end money-makers are drying up and they have to start making money on the trade fee. Just you watch -- others will follow.