The futures trading pits closed in the first week of July, but some grain customers may have been stuck and unable to get out of certain oddball spreads. We spoke to one broker who, in the final weeks of open outcry trading on the floor looked for a way to get one of his customers out of an unorthodox crush spread. CME Group was unable to find a solution and it is likely the customer had to leg out of each side of the spread at a cost as expiration neared.
The problem, according to grain market local trader Doug Redmann, is that the CME Group electronic trading system, Globex, is only set-up to execute standard crush spreads. For example, a normal December crush spread would involve selling December soybean meal and December soybean oil while buying November beans in a ratio of 11-10-9 (11 meal, 10 beans and 9 oil contracts). There are some other slight variations available, but, according to Redmann, more and more hedgers, particularly those hedging South American production, are doing what traders refer to as “oddball crushes.”
Because the protein content can vary with South American beans there is a greater call for non-standard or oddball spreads. “They cannot do any of these hybrid crushes [on the screen] or any numbers that are not 11-10-9,” Redmann says. ”You had hybrid crushes, oddball crushes, you have different ration crushes — those cannot be done [on the screen]. Those were being done in the pit up until now.”
Redmann is not just a local griping about the floor closing; he has traded the crush for more than 15 years and has even helped to develop crush options for the exchange.
While he and his trading group would make markets on the floor, they also trade on the screen, and floor trading would enhance overall liquidity.
“Even if we only do 1% or 2% on the floor, it generates more,” Redmann says. “The small percentage of these crushes we do on the floor [creates electronic volume as we] try and accommodate the spreads and possibly make some money, and that generates 80% of our volume on the screens.”
Redmann says there is an ulterior motive as locals would pay 9¢ on the floor and 14¢ on the screen.
“If you do 1 million contracts, that is $50,000; it is not insignificant money,” he says, adding, “It hurts the value of the seats.”
Innovation in bonds
A more common problem was in the financial pits where traders would execute calendar roll spreads with tails. CME Group officials had promised solutions to these issues — and at one point there was a rumor spread across the entire floor and to media covering the market that the CME had decided to keep some pits open in order for those spread to be executed — but sources on the floor say there is no solution.
Daniel Grant, a member who operates a desk for the DAW Division of Dorman Trading, says what the CME has done is add numerous different types of ratio spreads that all must be executed at one price.
What the locals on the floor were able to do is provide an edge to hedgers on the tail portion of spreads, giving them a better price than if they simply executed a ratio spread.
It is not true that there are no futures being executed through open outcry. Because the options pits are still open and covered option trades involve buying or selling a certain number of futures to “cover” that position, there are still futures being executed on the floor. Grant figured out a way he could execute Treasury spreads with tails in the pit after they closed. It would simply involve trading an out-of-the-money option along with the spread as a package. Covered spreads include a “delta,” which involves buying or selling a certain number of futures to cover the options spread. The delta of a covered option spread would refer to the amount of futures to trade to cover the option spread.
It wasn’t an idle threat as Grant had lined up locals willing to make a market for such an order. Obviously the strategy Grant contemplated, using so called “garbage options,” is a workaround for closing the futures pits. Apparently it is completely legal according to exchange rules, though when Grant ran it by exchange officials they said he could not execute such an order.
While this is obviously an attempt to find a loophole to trade calendar spreads with tails on the floor, it is something that could possibly save a considerable amount of money for an end user of the exchange, providing that customer a better fill.
This is the type of innovation that led to the explosive growth of these products. It is also something that may be going away with the floor.