Stock talk for the main street investor.

Your Personal Tax On Wall Street

It’s become apparent that Wall Street runs the world. Whether it be bailouts or incredible pay packages, they’ve gained enough power to seem nearly untouchable. So, lets make some money from Wall Street. One of the trends on Wall Street is investment banks moving more of their business into trading activities. They join hedge funds as frequent traders trying to take a little profit from every transaction. So how do we profit from this change in activity?

One way is by owning the exchange these traders use. NYSE/Euronext (NYX) is one of the largest exchange operating the New York Stock Exchange, Amex, Arca and Euronext. These exchanges provide a venue for people to trade stocks, bonds, futures, options, etc. They charge very low fees per trade and depend on volume to make their business operations profitable. A strategy that plays into the hands of trends in the market. In 2003 about 5 billion shares of stock were traded on the 10 largest exchanges, a number that has ballooned to nearly 35 billion in 2008. This is similar to trends in futures and options.

Though trends are to higher volume there is also increasing competition. Exchanges provide nothing more than a place to trade and are sensitive to prices and thereby losses of either buyers or sellers, who have very low switching costs. This is the reason for consolidation in the industry over the last few years. I believe this consolidation reasonably insulates the industry from new competition as the existing exchanges have sufficient users on both sides of the market and there is very little innovation that could steal these users.

Since this is a two-sided market there is a money side and a subsidy side. The subsidy side is the active traders who provide liquidity the market needs to provide buyers and sellers with a competitive market. The pricing pressure mentioned above is related to the amount of payment (yes, they get paid to trade) these liquidity providers receive. This is the biggest risk factor in their business, although I think it is manageable.

NYX is paying a 4% dividend currently and management has committed to increasing this in future quarters indicating confidence in their performance. A forward P/E of 11 is very reasonable and considering they’ve beaten estimates the last four quarters the company seems reasonably priced.

Tomorrow I’ll talk about playing subsidy side of the market with Interactive Brokers.

Disclosure: Author has no position in NYX.

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