Streetwise Professor

July 28, 2012

An Electronic ICE Age Freezes Out the Floor

Filed under: Commodities,Derivatives,Economics,Exchanges — The Professor @ 8:45 pm

The Intercontinental Exchange (not to be confused with the Intercontinental Railroad!) has announced the end of cotton, coffee, sugar, cocoa and OJ options floor trading.  The futures floor was closed some time ago.

The decision was spurred by the movement of options trading to ICE’s computerized trading system.  This is significant, and is likely the beginning of the end of floor trading.  Options have been the last major bastion of open outcry.  Many options trades involve more complicated multi-leg strategies (including spreads of various sorts) that are more difficult to computerize than simple outright futures trades, or simple futures strategies like calendar spreads, but which can be done efficiently on the floor: locals on the floors quote many of the common spreads.   If options can be done on the screens, there’s nothing really left for the floor to do.

Thus, we are witnessing the culmination of a process that began about 20 years ago.  I first did some research on electronic trading in the early-1990s, and remember the disdain with which the futures and options communities looked on computerized markets.  In 1995, I wrote a study comparing the electronic DTB and the open outcry LIFFE market which found that the former was as liquid, or more liquid than the latter: this study was met with much derision by LIFFE, and by most people in Chicago.  The derision of electronic trading died down substantially in 1998, when volume in the Bund futures market tipped completely to DTB’s successor (Eurex), and LIFFE suffered a near death experience.

The floor held out in the US for sometime longer, but by the early-2000s the writing was on the wall here as well.  By the mid-2000s options trading was keeping the floors going.  But that’s no longer true of ICE, and it is likely a matter of time before it is no longer true on CME/CBT or NYMEX.

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  1. I agree that electronic trading was inevitable but find it interesting that the ICE had to buy the NYBOT in order to kill it.

    Comment by Highgamma — July 28, 2012 @ 9:59 pm

  2. the problem is that the electronic traders get away with things that would never have happened in a pit. front running, running stops etc. the exchanges are on a direct path to industry concentration, and contraction.

    Comment by Jeff — July 29, 2012 @ 11:39 am

  3. […] – An electronic ICE age freezes out the floor. […]

    Pingback by FT Alphaville » Further reading — July 30, 2012 @ 1:09 am

  4. How is front running easier on a screen than in a pit, Jeff?

    Comment by Green as Grass — July 30, 2012 @ 2:43 am

  5. See figures 9-12 in this paper for a record of the transition to electronic trading in the ags:

    Transition is still remarkable however you slice it.

    Comment by Scott Irwin — July 30, 2012 @ 9:58 am

  6. @Scott-Thanks for that. The most interesting thing to me is the contrast between the rapid shift to electronic trading in the grains/soybeans, and the more gradual transition in hogs and cattle. The former is consistent with standard market microstructure theory, which implies that markets are “tippy” and should shift abruptly from one equilibrium to another. The result for hogs/cattle is rather surprising. Do you have an explanation?

    The ProfessorComment by The Professor — July 31, 2012 @ 3:56 pm

  7. The CME pushed the cattle and hogs to the screen. They wouldn’t have moved if CME didn’t actively lobby their customers to move. They are small markets and most of the customer base was pretty happy with them. As a matter of fact, some customers don’t like the way the market is electronically now in cattle and hogs. They are leaving. Combine that with the MF and PFG disasters and you have contraction.

    Grains are different. They are international in size and scope, and quite frankly, the CBOT had a far different culture to retail and outside orders than the CME. The outside customer was respected and taken care of first in the CME’s cattle and hog pits (not so in the pork belly pit which is a major reason the contract died). Grains have a huge dollar volume of international trade. US Meat isn’t like that.

    This is my gut feel as to why the difference.

    Comment by Jeff — August 2, 2012 @ 6:17 am

  8. Gentlemen:

    Are there any areas of the world where markets are developing/evolving in which open outcry (or cellphone bid/ask) quotes are exchanged? i would think perhaps less sophisticated sections of Africa or Asia where markets need clearing & buyers & sellers need representation.

    There is nothing like watching the interaction. Advancing technology makes it hard to ‘watch.’ -cjw

    Comment by Chuck — August 2, 2012 @ 4:12 pm

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