Commodities and Futures: The last word for open outcry

LOCAL traders - self-employed professionals who trade the markets for themselves - occupy a critical position in the vibrant US futures and options industry.

These gutsy entrepreneurs pit their wits daily against the financial might of the world's giant banks, investment houses and food conglomerates, betting on the direction of grain, bond or metal prices. They trade futures, which are paper contracts for delivery of commodities or financial instruments at some future date, and options, another type of contract based on financial or agricultural instruments.

The locals stand for hours on end in tiered, crowded trading pits, shouting and waving their arms. The work is so demanding that medics stand by to rescue victims of heart attacks, angry brawls or accidental injuries caused in the crush.

In Chicago, locals are shareholders in the exchanges, and often act as brokers for big firms, as well as themselves. The talented can make money on the most minute price movement, even on a slow day.

Locals are speculators, because they use futures to profit from price movements, not to hedge financial risk. But the exchanges need them to enhance liquidity - an active trading environment where buying and selling can occur with minimal price disruption. On the Chicago Board of Trade, the world's largest and oldest futures exchange, locals provide an average 60 per cent of daily trading volume.

When the London International Financial Futures and Options Exchange started in 1982, its founders thought Chicago's exciting, open outcry trading style so compelling that they copied it exactly, even down to cultivating locals. Today Liffe is the world's third-largest futures exchange.

Locals thrive on other US exchanges, but in Europe they are found only on Matif, the Paris exchange, on the European Options Exchange in Amsterdam, and in London. On newer exchanges, all fully automated with no trading pits, locals cannot exist.

But in Chicago, there are signs that the locals' dominance is waning. Powerful managed futures funds controlling huge pools of investors' money are squeezing them out. Pat Arbor, the CBOT's chairman, cites their dwindling influence as one of the main changes affecting the industry. 'Our volumes have grown 14 per cent this year, but our customer base is changing,' he said on a visit to London last week. 'The retail customer as we know it in the US is vanishing.'

Today, 97 per cent of CBOT customers trading through brokers are institutions. Recently, three CTOB locals sold their memberships, all to foreign banks.

Managed money is becoming king worldwide. It comes from private investment funds run by trading advisers such as George Soros and Paul Tudor Jones. It also comes from banks, securities houses, insurance companies and pension funds, increasingly using derivatives to diversify their portfolios.

Many of these funds are driven by computer programs that give buy or sell signals when prices in an active futures market hit a certain point. They can create a tidal wave effect when they all move simultaneously, causing sharp price swings and hurting those on the 'wrong side' of the market.

Some CBOT locals have complained that the orders assailing the pits these days are too big for them - they cannot afford to take on such large risks. But the CBOT, a mature exchange seeking new business, is continuing to make technical changes to enable the large institutions to trade more easily.

If these developments cross the Atlantic, there may be a quiet revolution in the futures and options business. First, investing in derivative instruments is increasingly a game for the big institutions. If a private citizen wants to play, he must do it by their rules, in a professionally managed fund.

Second, if locals become an endangered species and the big institutions provide sufficient liquidity, who needs trading pits?

The notion of trading pits becoming obsolete was popular in the mid-1980s, as enthusiasts predicted the spread of 24-hour, global electronic futures and options trading. This has not happened, but the evolution of financial markets may bring the same end result over time.

Nearly all derivatives exchanges launched since the late 1980s are fully electronic. Sadly, the changing nature of financial flows and advancing technology may sound the death knell for the noisy hurly- burly of open outcry trading.

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