Chicago Board Pit Brokers Confront Electronic Future (Update1)
Aug. 21 (Bloomberg) -- Chip Kenyon is staring into the pit. Wearing a sky-blue trader's jacket and a red tie dotted with green moneybags, Kenyon, 41, ducks under the rail girdling an octagonal amphitheater 5 feet high and 40 feet across on the floor of the Chicago Board of Trade.
Minutes later, he starts barking orders for futures on 30- year U.S. Treasury bonds and simultaneously signaling with his hands: palm out to sell, palm in to buy.
Kenyon does the most business of all the independent traders, or locals, in the CBOT bond pit -- and he wonders how long he'll survive there.
Since the U.S. Treasury said in October 2001 that it would stop issuing 30-year bonds, floor trading in bond futures -- previously the CBOT's most active contract -- has plummeted 37 percent to 70,100 contracts daily, from 111,400 contracts.
Kenyon remembers when as many as 700 sweating, shouting young traders in jackets of red, green, yellow and purple squeezed into the 30-year pit each morning. Now, their number has dwindled to 150. Almost one hour into a session in June, he's traded 500 contracts with an underlying value of $50 million, a far cry from his one-day record of 74,000 contracts.
``We're obviously a dinosaur,'' says Kenyon, an 18-year board of trade veteran.
Eurex Threat
The fate of a single futures contract is but one worry these days for the board of trade and its shrinking core of floor traders.
Eurex AG, an all-electronic bourse that didn't exist five years ago, has eclipsed the 155-year-old CBOT as the world's busiest futures exchange. Futures -- agreements to buy or sell specific securities or commodities at a specific price on a certain date -- are part of a $729-trillion-a-year market in exchange-traded derivatives, a family of instruments that also includes options.
Eurex and the board of trade could scarcely be more different. Formed in 1998 by Deutsche Boerse AG and the Swiss Stock Exchange, Eurex is based in a glass-and-steel office tower in Frankfurt and has no members and no trading floor. It employs 142 people.
The Chicago Board of Trade, by contrast, was founded in 1848, above the Gage and Haines flour store on Chicago's Water Street; it's the world's oldest futures exchange. Today, the CBOT has 3,624 seat-owning members, 669 full-time employees, 115,150 square feet of trading halls and 19 pits in which derivatives ranging from corn futures to U.S. federal funds rate options change hands.
Electronic Edge
The outward differences mask a deeper -- and growing -- gap between the two: trading volume. In 2002, 801.2 million transactions coursed through Eurex, while 343.9 million contracts were traded on the CBOT. The Chicago Mercantile Exchange, meantime, has supplanted the board of trade as the premier U.S. exchange, handling 558.4 million contracts last year.
So far, Eurex has grown without going head-to-head with the board of trade. That's about to change: Starting in February, Eurex will be able to start trading its own contracts on U.S. stock indexes and Treasuries, casting even more doubt on the already-uncertain future of the CBOT floor traders.
Floor traders on the London International Financial Futures and Options Exchange have learned that so-called open-outcry trading faces an uphill battle in the 21st century. In November 2000, Liffe closed the last of its 24 pits and switched to an electronic system after Eurex grabbed the lead position in its most active contract: futures on 10-year German government bonds, or Bunds.
`Kicking and Screaming'
``The locals were dragged out kicking and screaming,'' says Amanda Sudworth, Liffe's director of fixed-income product management. ``They thought it was the death of everything.''
Ray Cahnman, a former CBOT director and the chairman of Transmarket Group, a Chicago-based proprietary trading firm, says the board of trade is protecting its floor traders at investors' expense. Electronic trading systems are faster and cheaper than humans in the pits, says Cahnman, who switched to computers after 24 years on the CBOT floor.
``This place is going down,'' Cahnman says of the board.
The CBOT has responded to the electronic challenge with its own computerized trading system, called a/c/e. The system was designed by none other than Eurex; the name stands for alliance/CBOT/Eurex.
Before a/c/e went on line in August 2000, one out of every 20 trades was being executed electronically -- via an earlier system called Project A. Today, half of all CBOT trades are transacted via a/c/e rather than face to face; this past July, 85 percent of the trading in 10-year Treasury futures, now the CBOT's most active contract, was done via computer.
Coming to America
After the Eurex/CBOT alliance expires next year, Eurex will be free to launch competing derivatives such as 10-year Treasury futures. On average, 560,000 10-year contracts with an underlying value of $100,000 apiece are traded daily on the CBOT, accounting for 32 percent of total trading. Eurex may grab a quarter of the board of trade's business in Treasury contracts when it pushes into U.S. markets next year, according to Joachim Mueller, an analyst at J.P. Morgan Chase & Co.
By expanding into U.S. markets, Eurex will become the world's one-stop shop for exchange-traded derivatives, says Eurex Deputy Chief Executive Joerg Spillmann. Eurex will level the playing field for investors by enabling them to bypass U.S. pits and execute trades more cheaply than they can on U.S. exchanges like the board of trade, he says.
``We're convinced we can add substantial value to the U.S. market,'' says Spillmann, 52.
CBOT Chairman Charles Carey, for one, says pit traders will endure. He says he has no plan to replace the exchange's time- honored open-outcry trading with a fully electronic board of trade.
Defending the Pits
``Electronic trading does a great job with the plain-vanilla contract, but when you get into the type of transaction that requires more than just pushing a button -- hitting a bid or lifting an offer -- the pit becomes valuable,'' Carey says. ``I think the pits will be around for some time to come.''
All the same, the board of trade has favored pit traders by making it expensive for members and nonmembers alike to trade CBOT contracts electronically. Nonmembers pay the CBOT $1.25 to execute a trade via a/c/e -- four times the 30 cents the exchange charges to trade via pit brokers. Members pay 15 cents to trade electronically -- more than seven times the 2-cent floor charge.
Eurex, by contrast, charges everyone the same price: 20 euro cents (22 U.S. cents).
``We want an exchange that respects electronic traders and lowers prices,'' says Cahnman of Transmarket Group.
Allan Zavarro, head of global futures at ABN Amro Inc. in New York, is more blunt: ``The board of trade should close down its trading floor tomorrow,'' he says.
Constituencies
Carey, 49, must maneuver between calls for change and the demands of the hundreds of traders, clerks and runners who pour into the CBOT's 45-story headquarters on LaSalle Street every morning. Carey, a grain trader whose grandfather served as chairman in the 1930s and whose uncle held the post in the '60s, is pushing to convert the member-owned board of trade into a for- profit company. To carry out his plan before his term expires in March 2005, Carey must win over competing constituencies.
Not all CBOT members are equal. The most powerful are the 1,402 full members, who are allowed to trade any or all of the 60 contracts listed on the board of trade, including those based on such agricultural commodities as wheat, corn and soybeans.
The 796 so-called associate members are restricted from trading agricultural futures and instead trade those based on Treasuries, the Dow Jones Industrial Average and the U.S. Federal Reserve's benchmark federal funds rate. As of early August, a full membership at the board of trade cost $380,000 and an associate membership cost $180,000.
`Ag Traders'
Full members who trade wheat, soy and corn -- ``ag traders,'' in CBOT parlance -- have been slow to embrace electronic trading. About 1 percent of the 270,000 transactions in these contracts daily are executed via a/c/e. One reason is that the board of trade has restricted a/c/e trading in agricultural contracts until after pit trading closes at 1:15 p.m.
To placate full members, Carey has promised to grant them the power to veto any proposal for a widespread shift to electronic trading in agricultural contracts. He's also proposed that the exchange award full members five shares for every one given to associates in the event the CBOT becomes a for-profit company.
CBOT CEO Bernard Dan says that much of the trading on a/c/e is in fact being done by traders on the floor. The board of trade has an edge over all-electronic rivals because it combines face-to- face trading and electronic execution, he says.
Computers on the Floor
For example, in the 30-year pit at the CBOT, Kenyon says he does much of his trading these days via a small computer slung around the neck of one of his five clerks. Throughout the day, the clerk provides him with a constant sotto voce commentary on the trades flickering across his screen.
``The role of open outcry is significant,'' Dan says. ``That's why there are still a lot of people down there.''
Another reason is that it can be cheaper to become a board of trade floor trader than to rent an office and trade via computer.
Chris Lundergan, 37, set himself up in the pit where futures on the fed funds rate change hands by leasing a CBOT seat from another member for $80 a month. For seed money, he borrowed $8,000 against his black 1984 Mercedes 300 SD, a gift from his father. Since hitting the floor seven years ago, he's invested in technology: a cell phone.
Advantages
``You can't open a hot dog stand for what it costs to set up business here,'' says Lundergan, by his own account the biggest market maker among the 60 or so traders in the fed funds pit.
CBOT pit traders have yet another advantage: market intelligence. On electronic systems such as Eurex, people trade anonymously. In the pit, traders know who's buying and who's selling. Is it a small-time local? A Merrill Lynch & Co. broker? The answer influences how much Kenyon is willing to buy or sell -- and at what prices. It also helps him build and protect his franchise on the floor.
After buying from a broker in the bond pit, Kenyon says he knows he could've gotten a better price if he'd held out longer. Then why do the trade? ``I want to butter him up,'' Kenyon says. When the broker is looking to sell later at a lower price, Kenyon hopes he'll come back to him.
Lundergan says a computer could never replicate the in-your- face style of trading on the floor, where the decibel level or a few scurrying clerks can signal market sentiment. Traders at the Chicago Mercantile Exchange -- which, like the board of trade, blends open-outcry and electronic trading -- share that view.
Trading by Gut
``Sometimes I get out of a position for no reason -- just because I hear screaming,'' says Scott Fine, who's traded futures on the Standard & Poor's 500 Index at the Merc since 1987.
In the exchange-traded-derivatives market, the battle between human and machine extends beyond the CBOT. More than 95 percent of trading on the New York Mercantile Exchange still takes place via open-outcry trading. After the New York Board of Trade's World Trade Center trading floor was destroyed in the Sept. 11, 2001, terrorist attacks, that exchange set about building new pits.
Like his CBOT counterpart Carey, Merc Chairman Terrence Duffy sees little reason to shut down his trading floor. ``My job is to provide the best of both venues and let my customers decide,'' says Duffy, a 22-year veteran of the Merc's live-hogs pit who now trades exclusively via his exchange's Globex electronic system.
The Merc's Role
For now, the Merc is in a stronger position than the CBOT to fend off the Eurex threat. The 105-year-old Merc beat the board of trade to the punch by going public in a $166.3 million initial stock offering in December 2002. The Merc's stock rose 68 percent to $73.40 this year through Aug. 20, as trading in the exchange's futures on the S&P 500 and Eurodollars rose to record levels. The Merc is now the largest U.S. derivatives exchange, in no small part because trading in CBOT 30-year Treasury futures has plummeted.
Each Chicago exchange has carved out its own niche in financial futures. Contracts on the S&P 500, the Nasdaq 100 Index and Eurodollars -- based on the three-month U.S. interest rate on U.S. dollar deposits in non-U.S. banks -- are traded on the Merc, while those on 10- and 30-year Treasuries change hands on the board of trade.
At the CBOT, Kevin Buggy, wearing his lime-green and canary- yellow trader's jacket, leans against the railing of the 30-year Treasury options pit. He goes 20 minutes without executing a single trade.
``There are some days when you read the newspaper all day,'' Buggy says. ``And there are others where you don't eat lunch and you don't go to the bathroom.''
In the Bond Pit
Nearby, in the long-bond pit, Kenyon stands motionless, his left hand across his chest, his right hand at his mouth, so as to avoid inadvertently signaling an order. To his right, a broker shouts the price at which he's willing to sell and signals his offer with a flash of his hand.
``Sold!'' Kenyon barks, his hands shooting up.
Kenyon, who played hockey at Middlebury College in Vermont, has done well for himself in the pits -- well enough to donate money to his alma mater to build the Chip Kenyon Arena. Three years ago, sensing the move toward electronic trading, he tried his hand at trading via computer. He lost money and came back to the CBOT floor, hoping to eke out a few more years in the bond pit.
``I love this place,'' Kenyon says. ``I don't know where I'd go or what I'd do without it.''
Last Updated: August 21, 2003 01:01 EDT |
