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Patricia Campbell
Peregrine Financial Group, Inc. (PFG)
(312) 775-3411

CME Struggles To Shift Complex Options
To Screen From Pit

By Howard Packowitz

CHICAGO (Dow Jones) – CME Group Inc. (CME) faces an uphill battle to accomplish one of its key objectives: convincing its customers to trade perhaps its most complex derivatives product electronically, rather than in the trading pit.

The world's largest derivatives exchange boasts that it has made significant technological upgrades to its Globex platform to allow for electronically traded options tied to Eurodollar interest rate futures. However, CME reported just 7% of the average 925,000 Eurodollar options traded each day during the fourth quarter were performed on Globex, down from 8.7% in the third quarter.

"This has been the toughest sell in terms of migrating trading from floor to the screen," said Michael Gorham, director of the Center for Financial Markets at Illinois Institute of Technology's Stuart School of Business.

Exchange leaders have been eager for the past couple of years to speed up migration of Eurodollar options to the electronic platform because of cost efficiencies, and the ability of CME to collect electronic trading and clearing fees, all of which can boost CME Group earnings and its share price.

CME's Eurodollar futures are considered the world's most active futures market, with average daily volume of 2.2 million contracts traded during the final three months of last year. CME has successfully persuaded participants to trade Eurodollar futures – which reflect three–month settlement expectations for the London Interbank Offered Rate, or Libor, and are used by investors seeking exposure to U.S. interest rates – on Globex. More than 90% of Eurodollar futures trades were performed electronically in 2007 and so far this year, up from only about 5% as recently as 2003.

CME spokeswoman Pamela Plehn said the "small decline" in the percentage of Eurodollar options traded on Globex in the fourth quarter was due in part to the increased market volatility during the last few months of the year, which caused traders to "shift to a trading style that they're most familiar with."

Financial stress in credit markets, due to the collapse of U.S. subprime mortgages, contributed to the heightened volatility, thanks to Libor fluctuations and expectations that the U.S. Federal Reserve would reduce its benchmark federal–funds rate.

"We all seek that which is comfortable during times of uncertainty," said Gorham, although he said CME has "invested a lot of money to make electronic trading more user–friendly."

However, Eurodollar options provide vastly different challenges for traders and for the electronic system. Options grant participants the right, but not the obligation to buy or sell futures contracts at a specific strike or underlying futures price.

Traders can bid on multiple strike prices for rate expectations running out as long as 10 years, with "an infinite number of (trading) possibilities," said Russ Wasendorf Sr., chairman and chief executive officer for the futures brokerage firm, PFG Best, formerly the Peregrine Financial Group.

"This is simply a symptom of technology not being adequately sophisticated yet," said Wasendorf, whose firm executes trades electronically and on the trading floor.

On an exchange–wide basis, electronic trading accounted for a record 81% of all traded contracts during the fourth quarter. That percentage included trading of agricultural commodities, which have been among the slower markets to migrate to the screen. But, the Chicago Board of Trade launched daytime electronic trading in August 2006, which significantly boosted activity for its agricultural product line. CME acquired its long–time city rival, CBOT, in July of last year.

CME shares have tumbled in recent weeks amid concerns about heightened competition, as a consortium of large banks and trading firms – hoping to lower their trading fees – announced plans last month to create a competing exchange. The stock was down 0.6% Wednesday at $594.16, well off its 52–week high of $714.48 set on Dec. 10.

–By Howard Packowitz, Dow Jones Newswires; 312–750–4132;