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Japanese marching into the fray of world futures trading

Kenneth Silverstein steps back from his post overlooking a sea of shouting people. ``When I started here in 1974,'' says the director of the Standard & Poor's 500 options pit at the Chicago Board Options Exchange, ``we had a pressed wood counter that was 10 feet long and one machine to process the trades. Now look.''

Hundreds of men and women in brightly colored jackets gesture wildly. Financial hieroglyphics glide by on electronic displays. Wires twist out of the backs of consoles like earthworms in a spring garden. There are so many heat-generating computer terminals at work here that the Options Exchange needs no central furnace; even in a Chicago winter, air conditioners blast away at computer heat.

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Next door is the Chicago Board of Trade, and several blocks away, the Mercantile Exchange. At these and exchanges like them in New York, London, and many other cities, a similar uproar and frenzy ensues each workday.

This is the futures and options business, the financial growth industry of the '80s - a brawling, bustling union of the commodities trade, which grew to prominence on the agricultural markets of this city of broad shoulders, and the stock and bond markets of more pin-striped locales such as New York.

In the past seven years, the futures industry has increased sevenfold. Today, the United States clearly leads the world in this business. More than 80 percent of all futures trading takes place through US markets. But, as in so many other US industries, these are anxious times.

Japan is on the march.

Where's Rod Serling?

To understand futures and options, one could think of stocks, bonds, and currency as commodities - not unlike the frozen orange juice that Dan Aykroyd and Eddie Murphy cornered in the movie ``Trading Places.''

(A guide to futures and options below.)

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Investors speculate on what these financial commodities will be worth several months from now. There's big money to be made doing this. Also big money to be lost. One hears tales of traders who score big, load up on Rolexes and Porsches, then lose big and sell everything, including their $300,000 exchange seats, overnight.

But while some people foolishly use financial, mineral, and agricultural commodities for gambling, the better traders are cautious, balancing long and short positions, puts and calls, and piecing together a respectably affluent living.

And it is not just a business for financial wizards or high rollers. Pensions, mutual funds, and money managers around the world pilot billions of dollars through the calm and storm of stock and bond markets each day. They increasingly use options, futures, and options on futures to hedge their portfolios in case the economic environment, the market, or an individual stock goes through an abrupt change.

This protects investment pools - money of the rich and famous, money that Aunt Alma socked into a mutual fund, and money that General Motors and hundreds of other companies have put away for workers' retirement.

Some farmers and ranchers still assail this citified paper trading as a way to manipulate their markets. And the gambling and high-leverage associated with these financial products rankle many observers. But few critics argue about the overall economic worth of futures and options any longer.

``There's no doubt that the futures markets in general serve by their risk-shifting and price-discovery functions,'' says Franklin Edwards, director of the Center for the Study of Futures Markets at Columbia University in New York. When used judiciously, he says, financial futures and options are a way of laying off risk on people willing to take it and of finding out what something is worth at any moment.

Beyond gambling and high leverage, however, concerns about the system remain.

Many professional investors, for instance, have devised sophisticated computer programs that trigger massive buying or selling programs depending on how stocks, stock indexes, and futures are performing relative to one another. This has led to some remarkable incidents in recent months, including a breathtaking 100-point stock market tumble during one hour on Jan. 23.

``It's frightening to see that kind of movement,'' says Gary Lahey, chairman of the executive committee of the Options Exchange and a floor trader in options on Hewlett Packard stock. ``The trading floors don't do that, but you find yourself watching the movement out there and going, `Where's Rod Serling?'''

Dozens of exchange seats went up for sale that night. But this volatility is not being initiated by the exchanges, Mr. Lahey points out. It is only being executed through them. The exchanges, in fact, ``allow massive flexibility to people in markets as volatile as these.''

Professor Edwards at Columbia, who is hosting a conference to study the impact of futures markets on the stock market on June 8 in New York, says the question remains one of whether stock-index futures increase or decrease volatility on the stock market - and what can be done about this. Inside the `trading factory'

During trading hours, outsiders stare down from mezzanine visitors galleries in the transfixed but puzzled way they would watch a street riot in foreign language. They are watching the ``open outcry'' auction system at work - constant, noisy bidding and trading.

Lahey calls his exchange a ``trading factory.'' All sorts of complex strategies are employed by floor traders, who may be independent owners of a seat on the exchange or affiliated with big brokers such as Merrill Lynch.

Some follow detailed trading programs, buying one moment and selling the next, laying off the risk of a big purchase in a series of smaller sales. Some are ``scalpers,'' chipping away, making minor amounts on each trade. Other traders communicate their deals by hand signals to comrades on nearby phones, who in turn are linked to another exchange. They practice what is called intermarket arbitrage, exploiting tiny differences in price moment by moment.

``In the pit,'' Silverstein of the Options Exchange explains, ``you can see things happening. People pay $300,000 for seats for a reason. They read the order flow. You don't learn the qualities it takes to do this in school. We have some math whizzes, some engineers, but there are people with varying backgrounds. The market is the great leveler.''

``It's not a casino,'' says Jay Sorkin, taking a break from his work in the Treasury bond futures-options pit at the Chicago Board of Trade. He is a third-generation floor trader; his grandfather began buying and selling commodities at the Board of Trade in 1920.

``There are very definitely ways to make money here,'' he says. ``It takes knowledge and discipline.''

Mr. Sorkin watches many technical factors, but his guiding rule is that ``a market at rest will stay at rest unless it is given impetus to move. There's no reason for it to go up or down on its own.

``The market is too big, too deep, to be pushed around,'' Sorkin says, even if powerful Japanese investors do what many economists worry they might do should the dollar continue to weaken: withdraw their money.

It always seems to come back to the Japanese. Americans want their business, their investment money, but worry about the competitive threat from the East.

Karsten (Cash) Mahlmann, chairman of the Chicago Board of Trade, considers it essential that the Commodity Futures Trading Commission enable the US to remain the world leader in this industry.

Ability to compete will be more and more necessary, he says, as Japan brings its own financial futures industry on line. The Board of Trade will start keeping evening hours on April 30 to attempt to garner business from Japan. It is also forging links with the London Financial Futures Exchange to position itself as an around-the-clock market.

But right now, says Mr. Mahlmann, ``the environment makes it tougher to do business at home than abroad. Yes, there have to be standards for customer protection, but some regulations are unwarranted.''

Among drags on the US futures industry, he says, are rules the commodities commission is considering which would boost the minimum capital requirements of brokers. This would protect customers in case other customers lost big amounts of money and the broker was threatened with a lawsuit. But Mahlmann and other officials say this requirement would boost costs and make US brokers less competitive.

Professor Edwards of Columbia thinks it makes more sense for the clearing corporations, which match up and settle trades, to be the ones that requires brokers to protect themselves better.

But he does not think the added cost in any case would be a ``significant competitive factor.'' Far from holding back the industry, Edwards says, customer protection under government, exchange, and industry rules probably attracts people to US markets.

The exchanges also complain that big Wall Street banks have introduced look-alike futures and options products, which are traded off-exchange by telephone. The Commodity Futures Trading Commission so far is looking the other way, but these products are lower-cost than those listed on the exchanges.

At the Chicago Mercantile Exchange, Leo Melamed, chairman of the executive committee, cites the need to ``lobby internationally for a level playing field.''

Mr. Melamed worked with economist Milton Friedman in the 1970s to develop a slew of financial products, including the currency futures of the Merc's pace-setting International Monetary Market.

The Merc has linked with the Singapore International Monetary Exchange on currency futures, and Melamed talks of working out further trading ties there and with the most prized exchange: Tokyo.

``The new world demands these linkages,'' Melamed says. ``We no longer exist in an independent market arena.''

As in so many other industries, a trade-protected Japan is coming on stream quickly. Japanese money managers are currently barred from trading on foreign futures markets, and futures contracts are springing up in Tokyo and Osaka. The yen bond contract in Tokyo is already biggest in the world in dollar volume.

``There is no doubt that Japan is going to be the colossal market of the East,'' says Professor Edwards, who visited Japan at the invitation of its Ministry of Finance last year. ``They intend to grow their own futures market while protecting themselves.''

That clearly displeases people like Melamed: ``We can't afford to be lulled into the belief that this is not a real concern. The technologies we utilize can be used anywhere.''

Chicago, in traders parlance, has gone long on futures and options is not about to close out its position. Translating puts, calls, outcries, and other terms from the futures and options markets Futures contract: A legal agreement to deliver or receive a specific amount of a commodity - whether frozen orange juice, Treasury bills, or a stock index - at a price set when the agreement is made. These contracts are traded on organized futures exchanges. Futures traders very seldom deal with real commodities, since almost all contracts are closed out before the actual delivery date. Option: the right, but not obligation, to buy or sell an underlying stock, bond, or futures contract. Using stock or commodity options, one can speculate with only a fraction of the money that would be required to buy or sell a real stock or commodity. Puts and calls: An option giving one the right to sell (put) or buy (call) the underlying futures contract. Going long (short): Buying (or selling) contracts and not yet closing out the position through an offsetting sale (or purchase). Futures commission merchant: Futures broker, licensed by the Commodity Futures Trading Commission, handling orders to buy or sell futures contracts. Open outcry: the noisy system in which vocal offers to buy or sell are made in pits on the trading floor of an exchange.

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