It's an outcry… the house always wins! Find out how you can profit from it…
by Siu-Yee Ng

Asians are notorious gamblers. Take it from me. I’ve been going to Atlantic City with my dad as long as I can remember. Once I was old enough to sneak into the casinos, I noticed that over half the gamblers were Asians. And I saw a fair share in Las Vegas, too.

Why else do you think the gambling industry in Macao, located right near Hong Kong and next to China, has been able to employ over half of the population in the special administrative region (SAR)?

It’s quite simple. Whether you’re gambling at the casinos or on the stock market, the reason is the same… to make money. One way to do that is to hedge your bets to minimize the risk. Options have long been a way to hedge your bets in the market. And in a minute, I’ll tell you how you can capitalize on the growing demand for futures trading.

Betting on the future

There are different ways to hedge your bets. In blackjack, if the dealer has an ace on top the player can buy insurance. In baccarat, you can bet on a player to win but still hedge your bets with the dealer. And in the market, you can purchase a futures contract to sell at a future date at a set price.

Futures contracts provide a means of hedging, risk management, asset allocation and speculation. And according to the Futures Industry Association, the total number of futures contracts traded on futures exchanges worldwide grew from 475 million in 1990 to 1.8 billion in 2001!

There are a number of reasons why futures trading has gained global popularity. Investors realize that with increased market volatility, risk management becomes a key element in holding on to their money. And buying a futures contract is a cheaper hedge than buying the financial institution or commodity.

Futures trading 101

Futures trading has traditionally occurred primarily on physical trading floors in arenas called pits through an auction process known as open outcry. Only members owning or leasing a seat on the exchange may trade in the pit, and orders from individual and institutional traders are sent to these members on the trading floor, usually through a broker.

Many exchanges also permit block trading, which involves the private negotiation of large purchases and sales away from the trading floor. These trades are settled and cleared through the exchange’s clearing facilities.

Futures exchanges also offer privately negotiated exchange-for-physical (EFP) transactions and exchange basis facility (EBF) transactions. EFP and EBF transactions involve exchanges of futures contracts for cash positions or other qualified instruments.

If you’ve seen the movie “Trading Places,” you get the idea.

Modern technology has made futures trading simpler for investors. Most futures exchanges provide electronic trading platforms, either exclusively or in combination with open outcry trading facilities. This allows subscribing customers to get real-time bid and ask prices and trading volume and enter orders directly into the platform’s centralized order book.

Examples of electronic trading platforms include the GLOBEX system, the a/c/e platform, which is provided jointly by CBOT and Eurex, LIFFE Connect and the eSpeed platform, which supports the Cantor Exchange (CX).

Going public

On June 10, 2002, the largest futures exchange in the United States and the second largest in the world, Chicago Mercantile Exchange Holdings Inc., filed to raise US$150 million on the open market.

CME was launched in 1898 as a not-for-profit corporation known as the Chicago Butter and Egg board. Over a century later, in November 2000, CME became the first U.S. financial exchange to demutualize and become a shareholder-owned corporation.

Now CME has to answer to its shareholders by adopting a for-profit approach to its business. CME posted record trading volume of more than 411.7 million contracts in 2001, an increase of 78.1% over 2000.

But 2002 is shaping up to be an even better year. Trading volume for the first half of 2002 has already totaled a record 259.2 million contracts. The second quarter of 2002 marks the sixth consecutive quarter in which new total trading volume records have been established.

In the first six months of 2002, investors traded a record number of interest rate and stock index contracts. This was in part to protect portfolios against market swings and possible U.S. Federal Reserve Board policy changes.

Knowing the business

CME brings together the buyers and sellers of derivative products on its open outcry trading floors, on the GLOBEX electronic trading platform, and through privately negotiated transactions that it clears. Investors can trade futures contracts and options on futures for interest rates, stock indexes, foreign exchange and commodities.

CME owns its clearing house and is able to guarantee, clear and settle every contract traded through its exchange. During the first quarter of 2002, CME processed an average of nearly 490,000 transactions per day. It currently has the capacity to clear more than one million transactions per day.

As of March 31, 2002, CME had US$27.4 billion in collateral. In the first quarter of 2002, it moved an average of US$1.6 billion of settlement funds through its clearing system each day.

In addition, 38 other exchanges and clearing organizations worldwide have adopted CME’s Standard Portfolio Analysis of Risk (SPAN) risk evaluation system, and both the New York Mercantile Exchange (NYMEX) and Euronext N.V. use CLEARING 21, CME’s state-of-the-art clearing system.

If I had to list all of CME’s accomplishments in the last century, I’ll need more than a couple pages in Taipan. But I can say this: if it weren’t for CME, the futures market wouldn’t be where it is today. In 1987, CME pioneered the concept of global electronic trading, and launched the GLOBEX platform in 1992.

Global network

Competition is increasing, but CME remains a leader in the industry. Remember, CME has been around for over a century and has ties with other leading derivative exchanges and clearing organizations in France, Spain, England, Singapore and Japan. CME has been able to extend the market reach of its global derivatives business.

And as part of its continuing effort to introduce new products based on new markets or securities, it recently formed OneChicago LLC, a joint venture with the Chicago Board Options Exchange (CBOE) and the Chicago Board of Trade (CBOT) to trade single stock futures and futures on narrow-based stock indexes.

CME also recently entered into an agreement with NYMEX to offer newly created small-sized versions of key NYMEX energy futures contracts for trading on its GLOBEX electronic trading platform. The products, based on CME’s successful E-mini stock index contracts, will be called e-miNY energy futures and will clear at the NYMEX clearing house.

Money talks

Like most exchanges, CME generates revenues primarily from its trade execution services, clearing services and market data and information services.

And with the recent increases in trading volume, revenues have grown as a result of increases in some of its clearing and transaction fees that became effective in the fourth quarter of 2000 and the first quarter of 2001.

Revenues have grown from US$177.6 million in 1997 to US$387.2 million in 2001. During the first three months of 2002, revenues, net of securities lending interest expense, were US$101.1 million, a 9.7% increase over the same period in 2001.

Total revenues increased US$29.7 million or 15.9% in the first half of 2002, compared to the same period in 2001. Net revenues increased US$21.7 million or 11.6%.

At the end of June 30, 2002, CME had cash and cash equivalents totaling US$48.1 million.

Cyberage

Online trading has become a quicker, easier and cheaper way to trade. So it’s important for CME to continue developing its online platform. For now, around half of its revenue is still generated from its open outcry facilities. Other countries have abolished open outcry altogether and have gone completely electronic.

In order to maintain a competitive edge, CME will need to complete the development of a new electronic functionality that will accommodate more products and markets.

Chicago Mercantile Exchange will be an IPO to keep an eye on. Other exchanges are in the process of demutualization. And if all goes well, we will see more exchanges trading on the open market. But remember, CME will be the first out the door, and thus the market leader.

CME has yet to announce an IPO date, but I will speculate that the underwriters will try to get this out the door before year’s end. The underwriters for this offering are Morgan Stanley & Co. Inc., UBS Warburg LLC, Salomon Smith Barney, J.P. Morgan Securities, Inc. and William Blair & Co.

For more Information on Chicago Mercantile Exchange Holdings, contact 30 S. Wacker Drive, Chicago, IL 60606-7499, tel. 312-930-1000, toll free 800-331-3332, fax 312-466-4410, website www.cme.com.