The exchanges have been one of the better places to hide in the financial sector this year. The banks and much of the real estate investment trust sector have been sold off on fears of credit-related losses. The exchanges, on the other hand, have benefited from the coronavirus-driven volatility, which has increased trading volumes and fees. Which exchanges are best poised for the future and which have some sort of competitive edge to help them retain their market share? Let's take a look at Cboe Global Markets (CBOE +1.44%) and Intercontinental Exchange (ICE 0.80%).
The pioneer in equity options
Cboe Global Markets began life as the Chicago Board Options Exchange, which pioneered the trading of equity options in the early 1970s. In 2017, the company merged with Bats Global Markets, which broadened the company's portfolio of products to include foreign exchange, cash equities, futures, and index derivatives. The options market includes both electronic and open-outcry trading.
Cboe is best known for its Volatility Index (VIX) products, which enable investors to gain indirect exposure to a basket of index options. Many investors consider high index volatility to be a market-timing signal and use it to hedge a portfolio of equities in lieu of index options. The VIX is also called the "fear index," and large spikes often are taken as a signal for a stock-market bottom. Low levels of VIX indicate complacency. There is an old market saw that says: "VIX is high, time to buy. VIX is low, time to go."
Image source: Getty Images.
The venerable stock exchange and mortgages
Intercontinental Exchange contains the New York Stock Exchange, the New York Board of Trade, and several other exchanges. It also includes Mortgage Electronic Registry Systems, which stores the servicing and ownership of mortgages. The company is also increasing its exposure to the mortgage markets through Simplifile, which promises to be a big part of the future of digital mortgages. If anything, the COVID-19 crisis shows the need for more automation in the mortgage process, and Intercontinental Exchange has a strong foothold there.
Valuation comparison
In terms of comparison, Intercontinental Exchange is about 5 times the size of Cboe. The latter does trade at a cheaper multiple and offer a higher yield; however, the difference is not large and could be attributed to its slower growth. In 2019, ICE reported revenue growth of about 4% compared with Cboe, which reported a 10% drop. ICE has also been a stronger performer this year, rising 5% year to date compared with a drop of 14% for Cboe.
| Company | Market Cap | 2020 P/E | Yield | 2020 Revenue Growth |
|---|---|---|---|---|
| Intercontinental Exchange (ICE 0.80%) | $53 billion | 21.7 | 1.23% | 11% |
| Cboe Global Markets (CBOE +1.44%) | $11 billion | 19.7 | 1.39% | 10% |
Source: Company Filings. Information as of Friday, June 12.
A new competitor for ICE
While Cboe is competing with other exchanges for options trading, Intercontinental Exchange is about to see a new competitor soon. The Members Exchange (MEMX) is a consortium of several large investment banks and investors aiming to offer a stripped-down version of cash equity trading. One of the partners is Virtu Financial, a high-speed trading firm accounting for roughly 40% of daily trading volume in cash equities. The loss of that volume alone is going to affect ICE, and MEMX could attract even further trading volume.
It's hard to love either stock right now. While the exchanges have benefited from the volatility in the markets driven by COVID-19, that volatility has been decreasing since the height of the crisis in early April. Both stocks are at the lower end of their price-to-earnings-ratio ranges and both have decent dividend yields. Cboe's growth is a concern, as is ICE's future competition. CME Group is a much more interesting exchange, so between ICE and Cboe I would choose neither.
