Derivatives exchanges in the United States. and Europe have been setting records for volume practically every week in 2001, thanks largely to institutional investors.
So far this year, the Chicago Board Options Exchange has seen five of its 10 busiest single days in exchange history. The CBOE also set a volume record in 2000, extending to five straight the years in which volume on the exchange has topped the previous year's.
Down the street at the Chicago Mercantile Exchange, April 18 saw the single busiest day in exchange history, with 2.8 million contracts changing hands, eclipsing the previous record of 2.3 million contracts set just over a month earlier. That high volume likely was driven by trading in interest rate futures following the Federal Reserve Board's surprise decision that day to cut interest rates by 50 basis points. But prior to the Fed's announcement, first-quarter 2001 trading volume on the CME already was the busiest ever, and the exchange also saw its busiest single month ever in March.
The Chicago Board of Trade also got in on the action, setting records in 30-day fed fund futures and Dow Jones industrial average index futures in March.
Across the Atlantic, both Eurex and the London International Financial Futures and Options Exchange announced record trading in derivatives products.
Volatility and time
A couple of events in 2000 set the stage for a boost in derivatives trading: Stock market volatility increased, and a number of exchanges opened to round-the-clock electronic trading.
"On the equity side, you have a change in the concept of growth and what likely growth rates were to be following the fallout of the dot-coms," said James McNulty, president and chief executive officer of the Chicago Mercantile Exchange. "When those prospects changed last February and March, we saw a ripple-down effect that took about nine months. It caused the market to expect correction and what we see is that volatility picks up during these correction periods. Volatility generally ends up causing increases in volume."
Although Mr. McNulty said retail investors are the fastest-growing segment of derivatives traders at the CME, institutional investors are by far the biggest derivatives users and are driving most of the volume.
Morgan Burkett, general counsel and chief legal officer for Cygnifi Derivatives Services LLC, New York, a spinoff of J.P. Morgan Chase & Co., said conventional wisdom holds that when markets become more volatile, investors start getting nervous.
"They see in the market that the price is starting to swing," Mr. Burkett said. "They will attempt to lock in or reduce the volatility by purchasing some form of derivative instrument, the underlying security of which they may or may not have a position in."
Among the big-selling derivative instruments are futures and options on interest rates. Take the eurodollar, for example. The eurodollar is U.S. currency held in foreign banks that is used to settle foreign transactions. Eurodollar securities promise to pay interest in U.S. dollars into those foreign accounts. Eurodollars are used as a benchmark interest rate in corporate funding.
Eurodollar futures and options are the most heavily traded futures contracts in the world. When the Fed cut interest rates 0.5% on April 18, eurodollar trading at the CME shot through the roof. Contract volume reached 1.6 million, easily passing the old record of 1.3 million set in 1994. Eurodollar options trading April 18 was 511,545 contracts, beating a record of 446,503 contracts set Jan. 4.
In all, eurodollar futures and options trading represented 75% of the total volume on the CME that day.
Also interested in equity
Plenty of investors also are interested in equity-based products. Trading on the CBOE of options on the DJIA hit a record April 12, with 106,346 contracts changed hands. It marked the first time options trading on the DJIA exceeded 100,000 contracts.
The record was set on a relatively calm day on the stock market. The Dow gained 31.62 points that day to close at 10,158.56, which was the index's highest close in a month.
The record also came as big-name companies like International Business Machines Corp. and Intel Corp. prepared to release their first-quarter earnings reports.
Institutional investors also have found easier access to derivatives exchanges, thanks to the growth of electronic trading. The CME, CBOE, CBOT, Eurex and LIFFE all announced or started electronic trading initiatives in the last year. LIFFE, for example, converted completely from floor-based, open-outcry trading to electronic trading in 2000.
Moving to fully electronic trading shifted the majority of the trade volume away from U.K.-based broker-dealers, Hugh Freedberg, chief executive of LIFFE, told LIFFE shareholders in March. Additionally, LIFFE expanded its access to 15,000 traders in 46 cities in 23 countries in every time zone around the world, Mr. Freedberg said.
The result has been monthly and quarterly volume records this year in both specific products and overall.
Increased volume also has led to better earnings for derivatives exchanges.
LIFFE reported a 14.6% increase in transaction fees in 2000, according to year-end results announced in March that cited "stronger trading volumes" as the reason. Greater revenue from fees, coupled with lower expenditures, turned a profit for LIFFE after two straight years of losses.
LIFFE Chairman Brian Williamson told shareholders he anticipates another profitable year in 2001. "Early signs are encouraging, with volumes in the first two months of the current year being 42% ahead of the equivalent period in 2000," he said. "In particular, there has been a notable rise in the exchange's equity business."
CME also up
Similarly, the CME reported first-quarter 2001 profits of $20 million, compared with a $2.9 million loss in the first quarter of 2000.
CME Chairman Scott Gordon cited the high volume, which he said was a result of market volatility; new CME products like side-by-side electronic and open-outcry trading of currency and cross-rate futures contracts; a new pricing structure; and better access to GLOBEX2, the CME's electronic trading system.
"While market volatility has increased demand for our risk management products, we are also seeing the results of new programs," Mr. Gordon said in a statement.
And many signs point to steady and even increased volume in the future.
During a 10-minute interview April 13, Mr. McNulty watched as the CME's electronically traded futures contract on the Nasdaq 100 index approached a record it had set just a few days before.
While he and others at the CME shy away from predicting volume, the stage is set for more records in the future. "More and more players are becoming more sophisticated and understanding not only the capital markets, but derivatives markets, also," Mr. McNulty said.