Cboe Global Markets, Inc. (CBOE) Q4 2014 Earnings Report, Transcript and Summary

Good morning and welcome to the CBOE Holdings Fourth Quarter 2014 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. Now, I would like to turn the conference over to Deb Koopman, Vice President of Investor Relations. Please go ahead, ma’am.

Thank you. Good morning and thank you for joining us for our fourth quarter conference call. On the call today, Ed Tilly, our CEO, will discuss the quarter and our strategic initiatives for 2015; then Alan Dean, our Executive Vice President and CFO, will detail our fourth quarter 2014 financial results and provide guidance on certain financial metrics for 2015. Following their comments, we will open the call to Q&A. Also joining us for Q&A will be our President and COO, Ed Provost. In addition, I’d like to point out that this presentation will include the use of several slides. We will be showing the slides and providing commentary on each. A downloadable copy of the slide presentation is available on the Investor Relations portion of our website. As a preliminary note, you should be aware that this presentation contains forward-looking statements which represent our current judgment on what the future may hold. And while we believe these judgments are reasonable, these forward-looking statements are not guarantees of future performance and involve certain assumptions, risks and uncertainties. Actual outcomes and results may differ materially from what is expressed or implied in any forward-looking statements. Please refer to our filings with the SEC for a full discussion of the factors that may affect our forward-looking statements. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, after this conference call. Now, I’d like to turn the call over to Ed Tilly.

Thank you, Debbie. Good morning and thank you for joining us today. Strong fourth quarter trading made 2014 a year for the record books at CBOE Holdings. Record trading at each of our exchanges, CBOE, C2, and CFE, combined for a total of 1.3 billion options and futures contracts traded an all-time high and an increase of 12% over the previous year’s total. The groundwork laid by our team to engage customers, develop products and broaden access to our marketplace positioned CBOE to increase CBOE Volatility Index, VIX futures trading by 26% and total options trading by 11%, outpacing U.S. options industry growth by several percentage points. We were particularly gratified to see record trading in our proprietary products, S&P 500 Index, SPX options and VIX futures and options. Increased trading across all product lines in 2014 drove new highs in key financial metrics, including revenue, earnings, and operating margin making 2014 our company’s fourth consecutive year of record financial results, a performance that allowed us to reward shareholders through increased quarterly dividends and share repurchases and to lay the foundation for ongoing growth in 2015 and beyond. CBOE continued to lead all 12 options exchanges with a total market share of 28.6% in December 2014, an increase of just over 1 percentage point from December 2013. I am pleased to say the momentum has carried into the new year. January average daily volume across all products traded at CBOE Holdings was 5.4 million contracts, an increase of 5% from December 2014. While we continued to see strong trading in VIX futures and SPX options, we saw a decline in VIX options trading, which we attribute to the unusual flattened VIX curve that we began to see in January. To give you a better sense of this, we thought we would show you what traders saw looking out at the VIX term structure, first in December, then in January. It’s very much a tale of two markets. In December, we see the normal contango we almost always see in the VIX curve, the upward slope that creates so many trading opportunities. Fast forward to January and we see a flattened term structure, which is an anomaly for VIX. This tells us the market is uncertain about both short and long-term risk, meaning that many position traders who use VIX options are temporarily on the sidelines. We fully expect the curve to return to its norm, which is in contago and with the return of contango, a return to the trading opportunities that have been temporarily negated by the abnormal term structure. Next, I will take a few minutes to discuss the 2015 initiatives, beginning with the opportunity for index options and futures trading overall. December 2014 Tabb Group study highlighted strong growth in U.S. equity index derivatives over the past 5 years and projected an additional lift of 6% this year. Over 90% of asset managers plan to increase use of equity index derivatives in 2015, citing market structure changes in the OTC and cash markets, as well as the inherent utility and versatility of the products themselves. Much of Tabb’s report corroborates our own observations and customer feedback. We also look to an ongoing macro shift from active to passive investments and more transparent index products as a powerful indicator and driver of continued growth in index trading at CBOE. Total dollars in passive investments more than tripled between 2004 and 2012 and are expected to triple again between 2012 and 2020, shifting from 11% of total assets under management in ‘12 to 22% by 2020. We expect this drive – we expect this to drive increased trading in index options and futures among fund managers who use these products to drive returns and hedge risk. We believe CBOE is uniquely positioned to benefit from the trends pointed to increased use of equity derivatives. Key to our strategy is expanding and leveraging partnership with index providers. We were pleased in December to enter into a licensing agreement with MSCI that enables CBOE to be the only U.S. exchange to list options on several well-known MSCI global indexes. We plan this quarter to launch options on the popular MSCI EAFE and MSCI Emerging Markets Indexes, with four others to follow later this year, pending regulatory approval. The global exposure afforded by MSCI Index products brings a new dimension to our index option franchise, which features options on prominent domestic indexes, including the S&P 500, Russell 2000, Dow Jones, and NASDAQ 100. Our MSCI partnership also provides us with the ability to create MSCI volatility products as a means to similarly bring global exposure to our VIX product line. In addition to forging partnerships with index owners, we continue to leverage our in-house product expertise to create proprietary index in options and futures. The ability to create our own products, such as VIX, puts CBOE on the licensor side of the equation, enabling us to create additional recurring revenues and extend our customer reach. As a result of our track record in product innovation and successful collaboration with index provider partners, CBOE not only brings new index products to the market, the market brings index product ideas and opportunities to CBOE. This virtuous loop enables us to offer our customers the world’s widest array of index option and volatility products and deep liquid markets in which to trade them. While product innovation is central to our unique value proposition, we are equally committed to mining the significant untapped opportunity in our current index product mix. In 2014, VIX trading volume increased by 8% over 2013, led by an increase in SPX Weeklys trading of 38%. It bears mention, given that we are frequently asked about the life cycle of growth in VIX trading that SPX volume increased at a compound annual growth rate of 16% over the last 10 years, a timeframe that represents years 21 through 31 in the life of SPX. More important, the aforementioned industry trends point to considerable headroom for increased trading in our flagship product. We plan to further grow SPX trading in 2015 through intensified educational efforts aimed at institutional investors, including OTC participants, fund managers, and overseas investors. We have mentioned in the past our ongoing educational efforts with the buy side, which despite the inherent leveraging and hedging power of SPX options has only begun to broadly embrace these products. After chipping away at this market for many years sometimes one pension fund at a time, we believe we are nearing an inflection point, where increased awareness in understanding of SPX options meets the opportunity created by the ongoing shift from active to passive funds and from OTC to listed equity derivatives trading. We recently commissioned a white paper on fund use of options, which found that options based funds have higher risk-adjusted returns and lower volatility. We have received great feedback on the paper from buy side customers in need of data-driven validation to increase their ability to use equity derivatives to manage funds. We will continue to expand our SPX marketplace globally in 2015. SPX options provide a means to take a position on the broader U.S. market with a single transaction and efficiency of particular appeal to overseas investors. This quarter we will enable a global customer base to more conveniently access SPX trading through extended trading hours. As announced this morning, the new SPX trading session will begin on Monday, March 9, following our launch of extended trading hours and VIX options beginning March 2. The new session for SPX and VIX options will run from 2 AM to 8:15 AM Chicago Time. Turning now to VIX Futures and options, further growing a thriving product line and marketplace is a major opportunity and priority for us. VIX Futures trading established a fifth consecutive record year in 2014 with average daily volume of 201,000 contracts, an increase of 26% over the previous year. VIX options trading – VIX options traded more than 632,000 contracts per day, a new record and an increase of 11%. Diversifying our VIX product line represents a significant means for CBOE to further define and expand the volatility space. On January 13, we began calculating and disseminating values for three new volatility indexes based on the prices of the most liquid FX options traded at CME, the dollar euro, dollar British pound, and dollar Japanese yen futures contracts. The new indexes offer the first ever measures of pure FX volatility and we look forward to developing tradable products based on them going forward. While we are excited about new products in the pipeline, we are also committed to developing markets for two important contracts launched last year. Short-term VIX VXST futures and options and Interest Rate VIX futures based on the CBOE/CBOT 10-Year Treasury Note VIX Volatility Index, VXTYN. We introduced VXST futures and options last year into what then became sustained headwinds of historically low volatility. Despite a slower than expected start, customer feedback confirms an appetite for short-term volatility trading and fuels our belief in the product’s potential. We will continue to work closely with end users, presumably under more favorable trading conditions to evaluate and adjust our approach as necessary. We view the November launch of VXTYN futures as the beginning of an ongoing opportunity to grow VIX trading, but caution that market is making inroads in trading is a longer term proposition. Interest rates represent an entirely new sector of volatility trading. Laying the tracks to reach and educate this new customer base will be an ongoing mission for our team. We look also to the opportunity to grow VIX trading overseas. After implementing near 24-hour trading in VIX futures last June, more than 9% of all VIX trading now takes place outside of regular U.S. trading hours. On days when there is breaking news outside of U.S. trading hours, we have seen that percentage rise to as much as 20%. With this quarter’s planned roll out of extended trading hours for SPX and VIX options, I am pleased to say that we will provide a growing worldwide customer base with increased access to our three fastest growing, most profitable products. We continue to leverage the efficiencies afforded by marketing a comprehensive index suite that enables market participants to hedge and trade global volatility, the global stock market, the broad U.S. stock market, and the U.S. small cap market and the world’s emerging markets. There are obvious synergies in using these products in tandem and develop and significant overlap among our customer segments. We leverage our marketing and educational efforts accordingly. We were pleased last year, for instance, to launch a newly enhanced cboe.com website as well as a new CBOE Mobile App that prominently feature our proprietary products. Both have tremendous reach and both will be further expanded in the coming year. This year, we will also expand our successful Risk Management Conferences, beyond the U.S. and Europe with the first RMC in Asia. RMC showcases our premium index products and attracts sophisticated and influential market participants who tend to be early adopters of new CBOE products and services. Embedded in all of our strategic initiatives are ongoing efforts to ensure that our systems are efficient, robust and secure. I am pleased to say we completed a major systems effort in the fourth quarter by separating CFE’s trading environment from CBOE, thereby greatly reducing the potential for any single point of failure in our marketplace. The continued rollout of extended trading hours and the implementation of numerous hardening and performance upgrades are priorities for us in 2015. Protecting the integrity of our markets is ingrained in all that we do. In December of 2014, we entered into an agreement with the Financial Industry Regulatory Authority, FINRA. Under that agreement, FINRA began to perform the majority of CBOE’s and C2’s options regulatory services on January 1. Alan will address the financial implications of the agreement, but I will note here that we believe the combination of FINRA’s regulatory independence and efficiency, with CBOE’s options regulatory oversight experience, further reinforces the integrity of our markets and investor protection. I will close here by noting that our record 2014 was the result of the sustained efforts and disciplined approach of our entire team to broaden access to our marketplace, expand our unique product set and grow our customer base. Our team’s ability to consistently advance these three strategic growth initiatives leaves us well positioned to meet the considerable opportunities on the horizon in this year and beyond. We couldn’t be more excited to build on that momentum. With that, I will turn it over to Alan Dean.

Thanks Ed. Good morning everyone and thank you for joining us. This morning, I will walk you through our fourth quarter results and then provide guidance on certain financial metrics for 2015. CBOE Holdings had another strong quarter, benefiting from more favorable market conditions and solid execution from our team. As outlined in the press release we issued earlier this morning, operating revenue was $166.5 million in the fourth quarter, up 17% compared with last year’s fourth quarter. Adjusted operating income was $88.8 million, representing an adjusted operating margin of 53.4%, up 220 basis points versus the fourth quarter of 2013. Adjusted net income allocated to common stockholders was $53.6 million, an 18% increase compared with 2013’s fourth quarter, while adjusted diluted earnings per share increased 23% to $0.64. Before I continue, let me point out that our GAAP results reported for the fourth quarter of 2014 include certain unusual items that impact the comparison of our operating performance. These items are detailed in our non-GAAP information provided in the press release and in the appendix of our slide deck. Turning to the details of the quarter, as this slide shows, the growth in our operating revenue was primarily driven by higher transaction fees. Transaction fees increased $23.7 million, or 24% from last year’s fourth quarter, due to a 15% increase in trading volume and an 8% increase in the average revenue per contract or RPC. Trading volume increased across every product category in the fourth quarter compared against both the prior year period and the previous quarter. Our blended RPC, including options and futures, was $0.34 compared with $0.316 in the fourth quarter of 2013. This increase mainly resulted from a shift in the mix of trading volume towards our highest margin products index options and VIX futures. The RPC in our options business increased to $0.284 compared with $0.275 in last year’s fourth quarter. The RPC on equity options and exchange-traded products declined by 9% and 16% respectively while the RPC on index options rose 5%. The RPC decline in the multiply-listed products was primarily due to an increase in volume discounts as market participants optimized the benefits offered in our fee schedule through higher levels of trading. On the futures side, CFE’s revenue per contract increased 3% to $1.62 from $1.57 in the fourth quarter of 2013, primarily resulting from a more favorable mix of trades by account type, as well as fee changes. As this slide depicts, the contribution from our highest margin index options and futures contracts accounted for 35.3% of total volume in the fourth quarter versus 33.8% in 2013’s fourth quarter. Converting the volume into transaction fees, you see that the index options and futures contracts accounted for 83.7% of transaction fees, up from 80.1% in the fourth quarter of 2013. Now, let me provide a few brief comments on some other revenue variables that influenced the quarter. Access fees were down about 5% compared with last year’s fourth quarter, primarily due to a decline in market maker permits. Looking ahead, we expect to see a similar decline for the full year 2015 and are projecting access fees to be down by about $3 million to $3.5 million this year versus 2014. Regulatory fees for the quarter increased $1 million compared with 2013’s fourth quarter, reflecting a higher rate for the options regulatory fee, as well as an increase in industry-wide customer trading volume. As we have pointed out in prior earnings calls, the revenue derived from these fees is only available to cover expenses we incur to carry out our obligations as a regulator. As a result, we make adjustments as needed to keep the revenue obtained from the options regulatory fee and related expenses in balance. For 2015, we expect regulatory fees to go down by about $2 million to $2.5 million due to the elimination of fees related to CBSX, our stock exchange which ceased trading in 2014, and a lower options regulatory fee rate compared to 2014. Now, let me turn to expenses. This slide details total adjusted operating expenses of $77.7 million for the quarter, an increase of $8.5 million or 12%, compared with last year’s fourth quarter. Adjusted expenses for the fourth quarter of 2014 exclude $1.9 million of severance expense, which relates to the outsourcing of the majority of our regulatory services to FINRA. Turning to core operating expense, this slide details fourth quarter core expense of $46.5 million. This represents an increase of $2.6 million or 6% compared with the fourth quarter of 2013, primarily due to higher expenses for outside services. The increase in outside services was mainly due to higher costs for legal expenses and contract services. The increase in legal expenses reflects the recognition of an insurance reimbursement in the fourth quarter of 2013, with no corresponding benefit this year. Volume-based expenses, which include royalty fees and trading volume incentives, were $20.2 million for the quarter, an increase of $3.9 million, or 24%, primarily reflecting a $4.2 million increase in royalty fees. The increase was mostly due to higher trading volume in licensed products, which include index options and VIX futures. In addition, royalty fees included higher fees associated with our market data sales and fees linked to certain order flow for contracts directed to CBOE. Effective for 2015, we are making some adjustments to royalty fees to improve its alignment with the trading volume of licensed products. Going forward, the fees linked to order flow will be reported as contra-revenue offset against transaction fees. This change should result in a more consistent metric for modeling royalty fees and better align the trading volume for licensed products with royalty fees. Taking these reclassifications into account, we expect the royalty fee rate per licensed contract traded to be just under $0.15 for the year, reflecting a rate of about $0.14 for the first quarter and $0.15 in subsequent quarters in 2015. Volume from all index options contracts traded, VIX futures and any other licensed contracts should be taken into account for this expense projection. Our GAAP effective tax rate for the quarter was 41.2% versus 36.1% in last year’s fourth quarter. The increase in the effective tax rate for the quarter was primarily due to tax adjustments related to changes in our assessment of uncertain tax positions and a lower benefit from discrete items versus the prior year quarter. Excluding the tax adjustment related to a prior period, which is included in our non-GAAP adjustments, the effective tax rate was 39.4% compared with 36.1% in the fourth quarter of 2013. Let’s turn now to a few highlights related to – relating to our balance sheet and capital allocation. In 2014, we generated more than $263 million in cash from operating activities, which enabled us to return more than $67 million to shareholders through regular dividends, $44 million through a special dividend and more than $177 million through share repurchases. Through share repurchases, we reduced shares outstanding by 3% in 2014. Since our share repurchase program was implemented in August of 2011, we have reduced our shares outstanding by 6%. Our capital position remains strong, ending 2014 with cash and cash equivalents of $148 million. Our approach to capital allocation remains unchanged. We look first to fund the growth of our business and then to return capital to our shareholders through sustainable quarterly dividends and share repurchases. At December 31, we had $90 million remaining on our share repurchase authorizations. We consider both dividends and share repurchases important in providing additional value to our stockholders. Few days ago, we announced that we declared a dividend of $0.21 per share for the first quarter of 2015. Now, I will provide some guidance for you to consider as you refine your models for 2015. Looking at core expenses for the full year 2014, we came in at about $189 million, in line with our guidance range of $186 million to $190 million, which we provided back in August. For 2015, we expect core expenses to be in a range of $195 million to $199 million, an increase of 3% to 5% versus 2014. This increase primarily reflects higher expenses for data processing, business development, which is included in travel and promotional expense, and outside services. In addition, we expect a reduction in employee costs as a result of our regulatory services agreement with FINRA. As Ed noted, CBOE and C2 entered into an agreement with FINRA to perform the majority of the exchanges regulatory services. As part of this agreement, many employees of CBOE and C2 transitioned to FINRA in late December. As a result, in 2015 you will see our employee cost decrease and outside services increase. Our core expense guidance anticipates a net reduction in employee costs of approximately 8% or $10 million with a net increase in expenses related to outside services of 45% or about $14 million. While there are other variables impacting these line items, the FINRA agreement is the most material. The net increase in employee costs for 2015 represents staff reductions resulting from the FINRA agreement net of increases for staff additions, merit increases and incentive compensation. Adjusting for the impact of the FINRA agreement, employee costs would increase and outside services would be relatively unchanged in 2015 compared with 2014. Under our agreement, FINRA will utilize CBOE’s regulatory software over a transition period. As a result, we are accelerating the depreciation of certain regulatory software to be fully depreciated at the end of this period, which will add about $3 million to depreciation and amortization expense in 2015. Continuing stock-based compensation, which is included in core expenses, is expected to be about $12 million for the year. The decrease versus 2014 is due to the final vesting in June of 2014 of stock awards granted in 2010 following our IPO, offset somewhat by new grants awarded. Depreciation and amortization expense is expected to be between $46 million to $48 million, reflecting capital additions in 2014 and the accelerated deprecation for regulatory software I referenced earlier. 2015, capital spending is expected to be between $37 million to $40 million, down somewhat compared with the $50 million we spent in 2014. The heightened level of spending in 2014 supported our efforts to harden our systems. In 2015, the majority of our capital will continue to be used to enhance the efficiency and integrity of our trading systems. Finally, our effective tax rate is projected to be between 38.5% and 39.5% for 2015. In closing, 2014 was a great year and we enter 2015 well-positioned to continue to deliver solid results, while also continuing to invest for long-term growth. I am very optimistic about the opportunities before us and look forward to updating you on our progress throughout the year. Thank you for your interest in CBOE. And I will now turn it back to Debbie, so we can take your questions.

Thanks, Alan. At this point, we would be happy to take questions. We ask that you please limit your questions to one per person to allow time to get to everybody and feel free to get back in the queue and if time permits we will take second question.

Thank you. Yes, we will now begin the question-and-answer session. [Operator Instructions] And the first question comes from Rich Repetto with Sandler O’Neill.

Good morning, Ed. Good morning, Alan.

Good morning, Rich.

Hi, Rich.

I guess, Ed, thanks for the comments and color on the VIX term structure upfront. And I guess that’s my question is if you look at volatility, the volatility levels now were at pretty high levels, at least for the VIX, but we are not seeing like, if you look at your index option, as well as the VIX futures, they are not at commensurate high level as what you saw in the – it’s more like 2Q or 3Q or a little bit above. And I know you pointed towards the VVIX before, and that’s still running at 100. So, I guess this new tool helps us to sort of understand it, but are you saying that we would actually need a decrease in short-term volatility to see pickup in these index options and VIX futures?

Well, Rich, no. What we are saying is not necessarily a decrease in the front month, but rather this could be the new norm. If 19 is our new normal, I would anticipate them the back end of the curve slopping upward toward the mid 20s, 22, 23, 24, 25, that’s a pretty normal spread we can still remain in contango. So, what is unusual is just the flat shape? We don’t see that very often. I think you have to go back to 2008, 2009 to see this flat curve. Now, all of that said Rich, it’s about 3 weeks worth of data. So, we didn’t see this in December. We have just seen this in January. So, primarily just focusing on VIX options strategy, those are the users on the sideline. VIX futures while we saw some pretty terrific calendar spread trading pickup throughout the year, last year, there is very little attractiveness to trading that calendar when the difference between front month and October is less than a point. You really don’t trade in and out of that curve. So, what we have seen in VIX futures though to pickup the slack and why that’s still up month over a year is because the day trader is trading with much more frequency, because of the higher VVIX, but we have that calendar spread around the sideline in the futures. We have the term structure, the trade rolls up and down the volatility curve on the sideline in the options. That said, all the terrific backdrop for us in the flagship SPX which traded almost 1 million contracts a day in January, we have never seen anything like it before. So, the complex itself, trading the 500, hedging your exposure to the 500 is still very robust, we are pretty pleased with it overall. And I think a return to a normal shape of the curve brings back the VIX options trader and the calendar futures trader, while we are going to rely on the active day trader and the VIX futures in the meantime.

That’s very helpful. I think that gives sort of the segment of the different traders. Thanks. And I hope you watched that little game this past Sunday night.

We did indeed. Rooting for you.

Thank you.

Thank you. And the next question comes from Michael Carrier of Bank of America Merrill Lynch.

Thanks guys. Alan, maybe first a question for you, I think I understand what you were saying on the royalty fees, but I just wanted to make sure things weren’t changing, just the way that the calculation we will be looking at going forward will be on a contra basis, meaning the fees that you are paying into the market that’s not changing. And then just in kind of tandem with that, when you think about pricing just in general, whether it’s on the transaction side, the access side, market data, it seems like throughout the industry we are in a period where pricing is showing some signs of improvement, meaning the exchanges have more power. So, just wanted to get your take? I know you guys have done things in the past, but just wanted to get your take on how you see the dynamics in the current environment?

Yes, good morning Mike. Good question. Yes, to clarify the royalty fee issue, no, nothing new there. We are just taking out small amount of dollars that we showed as royalty fee expense and moving it up to transaction fees. And that item when we left it in royalty fees, sometimes messed up the correlation between royalty fees and the index and futures volume. And so just by moving it up, we think that will improve the correlation between that and nothing is new. And so the $0.14 in the first quarter, $0.15 for the rest of the year and that’s I think for the fourth quarter, we are at $15.2. So, you can see the impact of the dollars that are moving up to transaction fees. The impact on RPC, this is multi-list contra revenue that I am moving up to the revenue side. It will have a really small impact on RPC, a few tenths of a percent, a few tenths of a cent. So, that was the idea there. Now, on pricing, actually I have been saying this for a while and I am feeling better about it as time goes on. The way I look at pricing right now on the multi-list side, yes, there has been certainly stabilization in those line items. And that’s great. I think maybe we have all gotten it that dropping price may yield short-term gains in market share, but in a long run, competitors match and everybody is out revenues. So, on the multi-list side, it’s stable going forward. On the index options side, we have been able to acquire a few cents of RPC there over the past couple of years, but I would model stable pricing in that category going forward. And VIX futures, because of the size of the contract, it’s so large. The notional value that VIX future is so large, there is more room to move up there and you saw that. If you look at historical pricing there, I think you will see an increase in pricing in VIX futures. But we are very deliberate in what we do on pricing. These – the growth curves of SPX, of VIX options, VIX futures is so fantastic that what we don’t want to do is turn anybody off to these products because of fees. So, we are very careful about what we do there. I would much rather have an increase in revenue driven by volume rather than fees. So, that’s how I am viewing fees going forward.

Okay, thanks a lot.

Sure, Mike.

Thank you. And the next question comes from Alex Kramm with UBS.

Good morning, everyone. I just want to ask about market participants and growth in that regard. When we talk to people, index traders and things like that, it sounds like the last 6 months have seen a little bit of a slowdown in I guess what those guys are seeing in terms of new people connecting and trading. So, just wondering if you are seeing the same things or if it’s more like market-driven in terms of maybe the lead time of somebody like looking at the product set and then getting live is it’s taking a little bit longer or maybe different market participants just taking longer or moving elsewhere, because other areas look a little bit more exciting right now, so maybe flesh it out a little bit? Thanks.

Hi, Alex, it’s Ed Provost. So, as you know and we have discussed this, we have very, very experienced team both on the futures and the securities side engaging buy side clients, mostly institutional, some retail on a regular continuous basis both domestically and abroad. We evaluate the messages that are brought back on a regular and ongoing basis. We see as Ed mentioned, the little slowdown in the VIX options is very much being market conditions driven, no lack of enthusiasm, no lack of interest, still increased connectivity, especially on the futures side. So, we are – we continue to be very optimistic. We are looking at record attendance at our Risk Management Conference coming up in March, where we speak solely about the products that are proprietary to CBOE. So, we are – we couldn’t be more optimistic about not only the current user base, but those parties in particular pension space, who have not historically used our products, but who are adapting to using our products in the future.

Yes. I think also Alex this is an opportunity for us now with broadening the products that we are bringing globally. You couldn’t be more excited about a March launch and announcing that today for VIX options and SPX options. It really allows the team to get out there. And then of course MSCI to really offer to a growing customer base CBOE’s growing set of unique products only to CBOE. So, you may hear a more tempered approach but our sales guys couldn’t be more excited. And I think there is enthusiasm around both the ETH launch for options and MSCI in broadening our reach for global hedging.

Alright, very good. Thank you.

Thanks Alex.

Thank you. And the next question comes from Chris Allen with Evercore.

Good morning guys.

Good morning Chris.

I appreciate the color on then VIX term structure. And you referred that the last time you saw this happened was back in ’08, ’09, I am wondering, A, how long it lasted back then. B, what should we be looking at as indicators for potential change, is VIX open interest a good indicator for a change in the current environment right now that’s continuing to decline in January and February, will that start to pick-up and start to see it lengthening out, I mean a change in the term structure, any color there would be appreciated?

So, it doesn’t last long, just like when we see spikes when VIX in that normal upward slope contango, when we see spikes in backwardation where the front month is higher than the back months, that doesn’t last long either. Again, this is a very small data set of basically the last few weeks. What I would point you to similarly what we pointed you to in May is go to our CFE website. You get to see the term structure real time, the futures prices are up there today. They are up there every day in real time. And you can see basically 19% to 20.5%, 20.75% over the next 10 months, which is really, really flat. So, you will either see a new normal at 19% and upward slopping into the mid-20s or you will see the front month coming down. I can’t predict that. We use real prices of the S&P 500 options. And when those settle, you will see a change either to the front month, or you will see a new norm and the back month will tick up. I can’t predict time, I would say that a very unusual from a trader’s perspective to see moves in the S&P 500 of 3% or so in a given week, that’s really, really unusual. We have had – any given day, we can move 20 handles, that is historically, unsustainable. But again, I can’t predict the future. I use real prices like everyone else when I look out over that term structure. The website will tell you, will give you a pure good look into what those that are insuring the 500 are willing to pay for insurance.

Got it. Thanks guys.

Thank you. And the next question comes from Christian Bolu with Credit Suisse.

Good morning guys, thanks for taking my questions. On extended trading hours, clearly it’s been a big success in the futures world. As we think about SPX and mortgage securities world, is there any difference in the customer base or behavior that would mean extended trading hours are more or less successful relative to the experience with futures?

Yes. I think the difference is really the futures industry is we didn’t introduce extended trading hours in the futures industry. We picked up an industry who is used to trading around the clock. For example, Globex has been opened 24 and three quarter hours for quite some time. We love that, we follow that model and have been very successful in trading VIX futures in non-U.S. trading hours. Uniquely, now CBOE will launch on the security side, SPX options and VIX options. So there is a difference. There is a different user base. We are excited about it. Our most active traders are looking forward to the launch. We have got liquidity providers testing with us and ready to provide some really meaningful quotes. So it is different, it is unique. CBOE paving the way again for introducing and allowing access into the U.S. market in the non-U.S. trading days. So I would point out the biggest difference is the futures users are used to this and the securities guys this will be new and CBOE is bringing that to the marketplace.

Great. Thank you.

Thank you. And the next question comes from Kenneth Hill with Barclays.

Hi, good morning Ed, good morning Alan.

Good morning.

Good morning.

I wanted to talk a little bit about the new products. So I would assume getting a new product off the ground, if you are going to need some buying from not only market participants as well as guys like market makers and liquidity providers there. What do you guys see as impediment to partnering up with dealers and market makers to come in and back new products like the 10-year VIX. And what kind of things can you guys do on your end to help incentivize them to get in and make markets for those new products and get them off the ground. And I guess on a related note, are there certain products that are more difficult to get buy-in for versus others?

Yes. So, let me start, I am going to turn it over to Ed Provost, there certainly are ones that come more naturally to us and ones that present a bigger challenge. What we said on the launch of the 10-year is getting into the fixed income space is new to us. It’s new to our liquidity providers and it’s going to take a longer lead time. What’s more natural obviously is extending trading hours in products that are in our core, SPX options and VIX options and extended trading hours, different challenges, but once that we are much more comfortable with. I would point out that you mailed, we need to launch new products, first with liquidity. And as we go back and look at our successes, it’s because we have got anchored tenants posting liquidity from the opening bell to the closing bell in meaningful quality markets. And without that, new products are not setup to succeed. We think we do a very good job of that. But I will turn it over to Ed and he can touch on some of what we are hearing from his business development guys.

So, yes, just add to what Ed said, it really is a balance of the liquidity provision and getting order flow providers prepared for and to promote the use of the products. VXTYN, whole new product set for us, a much bigger challenge in getting continuous liquidity in that product, but we have gotten that going that we think pretty well. MSCI products pretty much are consistent with our current mainstream products, won’t be a big challenge. Extended trading hours in VIX and SPX options, we have three dedicated DPMs starting at 2 AM, we feel very, very good about that. So it has a lot to do with the product and the space that we are operating in. The closer it is to our historical product line, the better it is, the newer it is, the greater the challenge. And that’s true on the order flow side as well. The users of the VXTYN, a different user set for us. So, new people to meet, lots of more – lots of greater challenges in engaging that audience as opposed to again MSCI products which is basically the same user set that we are running into all the time at our Managing Directors Conference. So, different products present different challenges. As we look to diversify our product set, we will find ourselves engaging new users both on the liquidity provider side and the order flow side. But, we have recognized that and we are well equipped to handle both.

Great. Thanks for taking my question.

Thank you. And our next question comes from Patrick O'Shaughnessy of Raymond James.

Hey, good morning guys.

Good morning Pat.

So, a question on the market data fees line. You guys are seeing some really nice growth in that area, kind of in the first half of 2014 and I think you attributed a lot of it to growth in your futures exchange market data, is that something do you think there is still some more upside left, because it seems like you obviously have a very viable property and there is probably more ways that you can monetize that?

Yes. That’s a great question Patrick. In 2014, we saw three things happen in market data fees. First of all, we had an increase in market share and that drove our operating revenue. So, operating revenue is driven by each exchange’s share of industry options trade. So, that was a big driver in 2014. But we also saw some pricing changes affect that line item and that drove another although other smaller part of the increase. But the other two items that were drivers were CFE, our futures exchange market data fees, which we continue to see growth in and our own streaming markets that we sell. So, the largest part was operating revenue, but we are seeing growth on CFE and our streaming market side as well.

Great. Thank you.

Sure.

Okay. Thank you. And the next question comes from Niamh Alexander with KBW.

Hi. Thanks. It’s Niamh Alexander. So and just on the MSCI and it’s quite a well known index. So, it could be a pretty exciting opportunity. Can you just help me think about how you are thinking about framing the product? Is it going to be primarily an electronic index? Is there an opportunity to kind of create something like the S&P with the pits? There already are ETFs or options on ETFs in place right now for MSCI products, but just help me think about how you are looking to? And right now I guess you haven’t ruled it out, but should we be thinking about this as being similar to your index options in terms of the pricing and whatnot?

So, I will let Alan talk to you about pricing, but I think you have nailed it. So, think of the success that we have had when we have looked at SPY. And as the SPDR ETF trader grows the size of the trades the complicated, the sophistication of the strategy, we have talked to those traders to move into the SPX. So, think of that in the exact same way. The MSCI contracts will be much larger notional value, cash settled European exercise. So, think pro, once you have begun and had success trading that ETF, we want to move those traders into the much more professional sized trade that will be offering options on for MSCI. So, exact same way. So, look to SPDR, look to SPX, and that’s what we hope to accomplish with the large institutional size contract that we are going to be introducing. Alan, on pricing?

Yes, I am looking pricing on these products similar to what we are experiencing in our index option side right now. So premium pricing, their license products and we will extract more value from those than we would on our multi-list side.

Okay. And it’s first quarter rollout, right?

Yes.

Yes.

Okay, fair enough. Good luck with it.

Thank you. And the next question comes from Chris Harris with Wells Fargo.

Thanks. Hi, guys. A quick question on the slide you guys have there on the passive assets, I thought it was kind of pretty interesting, but wondering if you could help us out a little bit more maybe trying to frame the opportunity there. Do you guys know how much derivatives a typical passive fund actually utilizes? And I ask that if you look at the expectations for 2020, $23 trillion of assets, maybe if it’s 5% that use derivatives that might help us frame up the market share a little bit better?

I can’t pinpoint exactly by strategy or by fund. I think what TAB points out that we are so excited about is the trend to what is basically the core for CBOE is really predicting that the hedging ability on the macro side and using these funds and the increase in the assets in these funds should line up well for CBOE’s complete suite, whether it’s the 500, whether it’s growth stocks in the Russell, whether now with MSCI with the trillions benchmark to MSCI, we think those benchmarks and those assets under management is going to grow. And we then see the continuation and the engagement of whether it’s on volatility related to those funds or the straight out hedging that we see today just growing over time. Ed?

Yes. So, I will add to that, Chris. Take a look at the white paper. It really is an impressive study of the fantastic growth of funds utilizing option strategies and the fact that people can increase returns. And in some cases, it actually reduced risk at the same time. So, I think that gives an addition to the TAB study a great perspective on the – on what I will call another form of the institutional use of options. We speak oftentimes about the pension space, but the fund space has grown fabulously as that white paper pointed out.

Yes. And then one more thought, I mean that’s the U.S. approach and I think the trend is just beginning globally and picking up exposure for us with MSCI really allows our guys to go out and we have gotten out two risk management conferences outside of the U.S. That’s just beginning for us. So, in our business development guys and our teachers go out, the suite now in attracting not just U.S. exposure and hedging that in funds, but rather now being able to use MSCI and that suite of products, it really opens a lot more doors for us.

Great. Thanks, guys.

Thank you. And the next question comes from Brian Bedell with Deutsche Bank.

Hi. Good morning folks.

Good morning.

Good morning.

Good morning. Just a question on the options, both multi-list and index options market share, obviously there has been some shift around with MX losing some share to Batz. Just wondered if you would comment on, first of all, whether that will have any impact on you? And then just looking at February, I know it’s only a couple of days in, but it looks like you have some lighter share in the index side and then little bit on the equity side. So, if you can maybe just – and maybe that’s just too early, but if you could just comment on those trends? And then just the timing of the MSCI launch and when you expect that to be material through revenue?

So, Brian, Ed Provost. MSCI launched I think end of first quarter and revenue impact obviously beginning there and going forward. As to the market share situation, been pretty stable, multiply-listed options very much in the 20%, 21% leading the group. We like the business. It’s not on a revenue per contract basis nearly as lucrative as our proprietary products, but we like the business. We compete aggressively and we feel as though we are optimizing revenue in that space. Our overall market share was obviously going to ebb and flow more based upon the activity levels than our proprietary products, but the market share wise, we like our position, it’s strong. And in my perspective, as it’s been pretty stable for a good number of months, I don’t read anything quite frankly into the early February numbers, but we feel – so this will be a strong market share year for us.

Okay, great. And then just RPC trends would be moving if we have softer volumes in 1Q that would be beneficial for RPC from a volume threshold basis on the options?

Well, you have to think about, Brian, mix. And so if you saw softer volumes and equity options and ETF options, but SPX and VIX and VIX futures remains strong than our overall RPC is going to jump. And conversely, if you saw an incredibly strong equity in the ETF category, it would negatively impact our overall RPC. I talked about RPC by category a few questions ago and so that’s how we are looking at our PC today.

Yes, okay, great. Thanks very much.

Thank you. And the next question comes from Ken Worthington with JPMorgan.

Hi, good morning.

Good morning.

If I calculated correctly, operating margins about 53.5% or so, I think that’s the highest we have seen. And you have a number of initiatives that continue to play out extended trading hours, product extension and so on. But as we think about the groundwork for growth, say over the next 5 years, just looking at the increase in margin, so call it high-quality problem. Are you investing enough or maybe is pricing really optimized to maximize revenue and revenue growth or maybe the answer here is the right margin level for CBOE is not really 50%, but it’s really closer to 60%. So, as we think about this improvement in margins, what’s kind of the right way to frame how we should think about this going forward?

We don’t manage the operating margin although, it’s a byproduct and it’s a formula. And I am going to be stating some things that I am sure are obvious to you, but it starts on the revenue side, coming up with proprietary products that we can charge premium pricing on maximizing the growth rate of our current product suite. I think we are doing that for education and business development efforts, other business development efforts there and that driving revenue, looking at fees and fees is much an art as it is a science. We have to be careful about what we do in fees and all of our product categories. And we think we are – but we want to maximize that revenue. In VIX futures, it’s possible to increase those fees, but I don’t want to do something that would stop the next big futures firm from trading VIX futures. I just wouldn’t want to do that. So, that’s part of the equation. The other part is the expense side and the leverage that margin doesn’t work unless we do the right job on the expense side. And I think we have a pretty good history of controlling expenses. I think our guidance for next year is – it should be no surprise to anyone, it’s I have always said 3% to 5% year-over-year on core operating expenses, that’s how it’s looking for next year again. And if we see volume downturns, we respond. And for instance in 2014, our initial guidance was in the mid 190s and we saw a volume downturn in the late spring and into the summer. We have responded by pretty dramatically cutting cost and lowering our guidance for the year. So, that’s the formula. I don’t guide to an operating or I don’t have a target for an operating margin number. All the pieces underneath have to be watched and worked on. And if we do the job there, then the operating margin works.

Great. Fair enough. Thank you very much.

Thank you. And the next question comes from Akhil Bhatia with Rosenblatt Securities.

Good morning. My questions have been asked and answered. Thank you.

Thanks, Akhil.

Thank you.

And the next question comes from Neil Stratton with Citi.

Good morning. Thanks for taking my question. I am sorry to do this, but I just want to come back to the January dynamics one more time. And most of the comments about the term structure were, I think, focused on the options. So, I just want to ask a question about the VIX futures. And the open interest does seem at sort of lower levels versus prior periods. I just want to see what are some of the dynamics behind it? And is there any impact specifically from the ETP market? Thanks.

So, yes, back to the same answer. So, VIX options are priced off of VIX futures. So, you are right to point out the futures, that’s basically that flat curve. What we used, if you look at the history and the growth of VIX futures, we began with a hedging vehicle for our market makers trading VIX options. You are right you point out the ETP growth driven by major institutions offering their customers sponsored ETPs that were designed to replicate exposure to various portions of the volatility curve. That growth was terrific and it really moved us to the next level. We picked up calendar spread traders and day traders as the daily volume got to a critical mass we are able to attract them. So what continues and what’s fallen away in a flat curve? What’s fallen away a bit is the calendar spread trader. As I said, there is roughly a point maybe between front month and October, so not really attractive trading in and out of calendars at this point, but what has really served us well is being able to attract that day trader with the volatility of volatility or VVIX up about 100. The day trader has more than compensated for the lack of interest from a calendar spread trader and we are up obviously this year about 220,000 to 225,000 contracts a day on the futures side. So, we think both the ETP, the calendar spread trader come back as the term structure changes and we think the VIX options trader comes back as well. I don’t know if that answered your question, but that’s the difference between the futures, why we still see the futures volume growing is because we have this day trader. It is very, very active in a 100 VVIX environment.

Sure. Thanks very much.

Sure.

Thank you. And we have a follow-up question from Alex Kramm with UBS.

Hello again. Just one quick one on the extended trading hours, you might have mentioned this, but is the pricing expectation the same one as well for index options, given that you might have some more traditional users versus market makers, HFTs things like that or is it comparable?

I think the same.

Easy enough. Thank you.

Thank you. And as there no more questions at the present time, I would like to turn the call back over to management for any closing comments.

Thank you. I want to thank everybody for their interest in CBOE and I am available all day if you have any follow-up questions. Thank you.

Thank you. Your conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.