Nasdaq Stock Market Inc on Wednesday confirmed it would acquire the Philadelphia Stock Exchange for $652 million, a move that will let the No. 2 U.S. stock exchange expand its presence in the fast-growing equity options business.

By taking over the third-largest U.S. options market, Nasdaq will handle about 15 percent of U.S. options trades. By comparison, market leaders Chicago Board Options Exchange and International Securities Exchange control two-thirds of that business.

This acquisition brings to Nasdaq an organization with a strong track record of building market share in a very competitive options marketplace, which has grown by more than 30 percent annually since 2003, Nasdaq said.

Reuters reported the pending takeover agreement on Tuesday.

Nasdaq, which previously announced plans to launch its own options trading market by December, edged out archrival NYSE Euronext and other bidders to buy PHLX, the nation's oldest exchange.

Nasdaq plans to preserve the options market, which is conducted both electronically and through a trading floor in Philadelphia. The Philadelphia Stock Exchange's operations will become part of Nasdaq's market services business.

HOT MARKET

Options markets are in demand since they offer higher margins than stock markets, where competition and the advent of alternative electronic networks have hurt trading volume and squeezed profit.

The business also has been growing rapidly. PHLX said on Tuesday that equity options volume in October was up 59 percent from a year earlier at 42.2 million contracts traded. It generated revenue of $108 million in 2006, compared with Nasdaq's $652 million for just the latest quarter.

Diversification seems to be the name of the game for exchanges at the moment, Celent analyst Cubillas Ding said.

The Philadelphia deal follows Nasdaq's agreement last month to take over the Boston Stock Exchange for $61 million. In September Nasdaq struck a deal to buy Nordic market operator OMX (OMX.ST: Quote, Profile, Research) jointly with Borse Dubai for about $4.9 billion.

These agreements follow Nasdaq's decision to abandon efforts to buy the London Stock Exchange (LSE.L: Quote, Profile, Research). The PHLX deal will be funded with Nasdaq's proceeds from the sale of its 30 percent stake in the LSE.

Nasdaq said it expected the Philadelphia deal to close in the first quarter and to boost earnings in 2009. Its shares were down 46 cents at $48.35 in early afternoon trading.

DEAL DETAILS

The deal will also bring Nasdaq a futures market operated by the Philadelphia Board of Trade, a small equities business and the Stock Clearing Corp of Philadelphia.

Robert Greifeld will remain CEO of Nasdaq Stock Market Inc, while Sandy Frucher will continue as CEO of the Philadelphia Stock Exchange.

Because much of Philadelphia is being preserved, analysts don't expect a lot of cost savings from the combination. Nasdaq declined to comment on job cuts, but said it saw savings from combining computer systems and platforms.

Celent's Ding cautioned: Buying into order flows is no guarantee that these flows can be successfully retained. There is a question mark around this aspect of how Nasdaq plans to retain flow.

And Fox-Pitt Kelton analyst Edward Ditmire observed that PHLX's owners, all brokers and dealers, may have less incentive to route their trades through Philadelphia after they sell.

Concerns exist that the transaction itself could loosen ties to these customers, Ditmire said.

PHLX is partly owned by Merrill Lynch, Citadel Derivatives Group, Morgan Stanley, Citigroup, Credit Suisse and UBS.

Investment London stock exchange NYSE Euronext