Rise of the Machines - Part Three

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...continued from Part Two.

CROSSING THE BOUNDARY
With so many electronic futures and options products on the market, the boundaries between the two industries have begun to blur. Lured by the non-fungible nature of futures products, the CBOE launched an all-electronic futures exchange in 2004. It currently trades a wide variety of products ranging from futures on the VIX to futures on ìgas at the pump.î The PHLX also followed suit with the PBOT, which offers binary event futures and other futures products. Given the monopolistic nature of these products, it is a safe bet that other options exchanges will soon venture into this territory.

While options exchanges are busy eyeing the futures markets, the futures industry has also begun eyeing the options markets. Lured by the recent explosion in options volume, futures exchanges have begun to make serious forays into the equity and index options world. Buoyed by the success of their E-mini S&P future, the CME has now added E-mini options to their product line. Their one-time rival and now potential merger partner CBOT has launched their own series of electronic options on their index products, including a mini-Dow option. The intent of these new products is to siphon off volume from the burgeoning index options markets that have been driving growth in the options industry.


So far, neither side has made significant inroads into the other sideís market share. However, the impact of this growing warfare between the two industries can already be seen felt in the marketplace. In October 2005, the CBOT and the CME released massive upgrades to their electronic platforms. A key feature of both of these upgrades was improved option functionality, including support for advanced order types and increased spread functionality. ìGlobex had already earned its stripes as a world class futures engine,î says Redding. ìHowever, we realized that we also had to make it into a world-class options engine. As a result, we focused a great deal of our energy in 2005 on improving its options functionality. One of the biggest improvements that we made in 2005 was to include mass quote in our e-mini S&P options.î Globex has since rolled out additional updates, including a recent change that allows the trading of complex options spread orders.

THE IMPORTANCE OF AUTO QUOTE
Mass quote, also known as auto quote, is perhaps the most critical technology in the options world. This technology allows exchanges to automatically update their option prices with every tick of the underlying. Without it, exchanges are forced to rely on market makers to keep their prices current. Unfortunately, in products that have hundreds of different strike prices, this is not always possible. Auto quote technology has been so crucial to the options industry that most traders canít imagine functioning without it. However, this important functionality has only recently become a standard feature in the futures industry. ìOne of the most frequent questions that we get from our customers is: why are your options quotes stale? In some cases, the quotes can even be from the previous trading day,î complains OíNeil. 

ON THE HORIZON
Crystal balls are remarkably inaccurate when it comes to predicting the future of the derivatives industry. In the year 2000, most industry participants believed that trading floors would be long gone by 2007. However, open outcry has shown remarkable resiliency in the face of electronic competition. ìFor most customers, there definitely is a preference for the efficiencies that the electronic platform offers,î says Tom Hammond, Vice-President of the CBOT. ìHowever, there is still a market for open outcry in situations where the broker can use his knowledge and expertise to leverage the pit environment.î

Nowhere is that market more evident than in the futures industry, where pits like the S&P 500 still maintain a thriving business despite growing volume in the E-mini contract. ìThe combined model of open outcry for the big contracts and electronic execution for the minis has worked very well,î says Redding. ìOne of the concerns that we had with the E-mini was that it was going to cannibalize our floor volume. However, when you look at the data, it has actually reinvigorated our trading floor.î

The whirlwind pace of change in the derivatives markets over the past seven years has left many participants scratching their heads in confusion. ìSometimes, when I look back on the past five years, itís amazing that Iím even around to give you an opinion on the next five,î says Tilly. ìHowever, despite all of the progress that electronic trading has made, the trading floors still offer a tremendous value added in both price discovery and complex orders.î

The ongoing tug of war between electronic and open outcry execution will undoubtedly continue for years to come. However, at the end of the day, the survival of either platform will boil down to customer choice. If one platform continues to add value in the marketplace, then it will continue to exist. But, as soon as that value disappears, so will the platform. ìI am not surprised by the resiliency of the trading floors. I never expected them to disappear,î says Krell. ìUtility is the key. As long as the floor continues to supply additional utility, then there will be a place for it.î
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