Streetwise Professor

December 30, 2016

For Whom the (Trading) Bell Tolls

Filed under: Clearing,Commodities,Derivatives,Economics,Energy,Exchanges,History — The Professor @ 7:40 pm

It tolls for the NYMEX floor, which went dark for the final time with the close of trading today. It follows all the other New York futures exchange floors which ICE closed in 2012. This leaves the CME and CBOE floors in Chicago, and the NYSE floor, all of which are shadows of shadows of their former selves.

Next week I will participate in a conference in Chicago. I’ll be talking about clearing, but one of the other speakers will discuss regulating latency arbitrage in the electronic markets that displaced the floors. In some ways, all the hyperventilating over latency arbitrages due to speed advantages measured in microseconds and milliseconds in computerized markets is amusing, because the floors were all about latency arbitrage. Latency arbitrage basically means that some traders have a time and space advantage, and that’s what the floors provided to those who traded there. Why else would traders pay hundreds of thousands of dollars to buy a membership? Because that price capitalized the rent that the marginal trader obtained by being on the floor, and seeing prices and order flow before anybody off the floor did. That was the price of the time and space advantage of being on the floor.  It’s no different than co-location. Not in the least. It’s just meatware co-lo, rather than hardware co-lo.

In a paper written around 2001 or 2002, “Upstairs, Downstairs”, I presented a model predicting that electronic trading would largely annihilate time and space advantages, and that liquidity would improve as a result because it would reduce the cost of off-floor traders to offer liquidity. The latter implication has certainly been borne out. And although time and space differences still exist, I would argue that they pale in comparison to those that existed in the floor era. Ironically, however, complaints about fairness seem more heated and pronounced now than they did during the heyday of the floors.  Perhaps that’s because machines and quant geeks are less sympathetic figures than colorful floor traders. Perhaps it’s because being beaten by a sliver of a second is more infuriating than being pipped by many seconds by some guy screaming and waving on the CBT or NYMEX. Dunno for sure, but I do find the obsessing over HFT time and space advantages today to be somewhat amusing, given the differences that existed in the “good old days” of floor trading.

This is not to say that no one complained about the advantages of floor traders, and how they exploited them. I vividly recall a very famous trader (one of the most famous, actually) telling me that he welcomed electronic trading because he was “tired of being fucked by the floor.” (He had made his reputation, and his first many millions on the floor, by the way.) A few years later he bemoaned how unfair the electronic markets were, because HFT firms could react faster than he could.

It will always be so, regardless of the technology.

All that said, the passing of the floors does deserve a moment of silence–another irony, given their cacophony.

I first saw the NYMEX floor in 1992, when it was still at the World Trade Center, along with the floors of the other NY exchanges (COMEX; Coffee, Sugar & Cocoa; Cotton). That space was the location for the climax of the plot of the iconic futures market movie, Trading Places. Serendipitously, that was the movie that Izabella Kaminska of FT Alphaville featured in the most recent Alphachat movie review episode. I was a guest on the show, and discussed the economic, sociological, and anthropological aspects of the floor, as well as some of the broader social issues lurking behind the film’s comedy. You can listen here.


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  1. World Trade Center building 4: NY COMEX. I spent several years in the late 90’s as a clerk at the NY COMEX, then also as a trader in the cotton pit…. I, due to my lack of Talent/skills/trading guts (being essentially an artist on an extended temporary break from my art), could not take advantage of the open outcry system – that others surrounding me could. I watched traders in inebriated conditions, after lunch, quite adeptly work their trades — not to mention other traders engaging in various suspect shenanigans and deals – a wild place – now history. I knew a trader that traded in our relatively sedate cotton pit, for amusement, I suppose, because he also owned a seat on the NYMEX – but preferred renting it out, rather than trading with the big boys there – rather he took in the regular income it provided each month without the risk.

    I always liked the fact that examples of the actual stuff we were trading were present at the exchange – there actually was a ‘coffee room’ near the coffee exchange with bags of coffee beans and other coffee grading paraphernalia – and a lonely attendant who lectured me on coffee quality – including why Starbucks was ‘Charbucks’ “Just buy’Eight O’Clock’ beans buddy – cheaper – better”

    Comment by Howard Seth Miller — December 31, 2016 @ 12:32 am

  2. Howard, was there an OJ room?

    Comment by Sam — December 31, 2016 @ 4:39 pm

  3. Was there an OJ room?…(or refrigerator) I don’t remember …and was there a cotton room? (bales for quick naps?) and a sugar room? (next to the coffee room?) They even had a potato exchange – that only someone named Pete seemed to trade…

    The OJ pit had less then 10 traders… not really a pit – a crease maybe.
    I was a poor trader who used to bring little bags of granola into the lunch room rather than buy lunch. One trader (a successful trader), who was my friend, spread the rumor that I was in fact a multi-millionaire eccentric – worth $100 million – that just had these very strange ways.

    Comment by Howard Seth Miller — December 31, 2016 @ 6:23 pm

  4. What if the problem is that the initial increase in fairness that was afforded by the transition to electronic trading is now being rolled back by the HFT firms? It sounds like you agree that the way they’re paying top buck to collocate their machines at the site of the exchange represent a return to the days when some traders had an edge.

    Comment by aaa — January 1, 2017 @ 3:39 am

  5. Fairness is a consideration for regulators of the retail end of trading. There is nothing inherently wrong with putting a price on access/latency at the wholesale end. Exchanges can differentiate themselves on how they handle this e.g. standardising cable runs with co-located platforms.

    Of course, as the Professor says, the impact on liquidity is important but that is also a HFT debate. I will be interested in the Professor’s take on his cospeakers thoughts on regulation. Although my bias is that simply redistributes externalities.

    Comment by noir — January 1, 2017 @ 4:49 pm

  6. Spent my life on the floor. I agree with your points about the value of a seat and the marginal trader. The problems with electronic markets are more complex. I do think there is a big problem with liquidity. When you want to unload a big order, it’s significantly tougher. When you want to execute smaller orders, it’s cheaper and easier.

    One problem with electronic markets that hasn’t been addressed is how you handle the nefarious trader. It is awfully tough to spot. In the pit trading days, humans would take care of the problem. The pits I traded in had a good culture of self policing where outside customers were heard, and taken care of. Bad actors were disenfranchised-we wouldn’t trade with them and they were out. Their reputation would precede them.

    The other problem is speed as outlined in Professor Roth’s book, Who Gets What When. When you trade on speed and not price, it screws with supply/demand. I think slowing markets down and matching trades differently will cause more volume to be shown on the bid/ask spread, damping volatility. Anyone who has seen the destruction of liquidity in the meat markets at CME can tell you about it.

    Comment by @pointsnfigures — January 3, 2017 @ 7:06 am

  7. I like what John Arnold said in the WSJ over the weekend- Good Riddance.
    The stealing that went on in NG was off the charts, Arnold is 100% correct.
    I will miss the $10,000 per box, Super Bowl pool, winner takes all-$1M.

    Comment by Tom Hend — January 3, 2017 @ 5:55 pm

  8. @AAA, the advantages gained by the broader market through electronic trade are not being rolled back by co-location and speed. It is significantly easier and cheaper to co-locate and access faster pipes than it was to locate meat on the floor. The evidence of this is the better liquidity and tiny spreads today vs the liquidity and spreads during the floor days.

    @Pointsnfingers, When has it ever been easy and cheap to move massive size? I don’t remember such a time. If you’re willing to compensate your counterparties by paying up for unloading size then you’ll find the bids you need. As returns to market making have declined so has the market makers ability to take on risk (size). This isn’t a mystery.

    Comment by Methinks — January 11, 2017 @ 12:09 pm

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