Streetwise Professor

February 4, 2015

Turn Out the Lights, The Party’s Over

Filed under: Clearing,Commodities,Derivatives,Economics,Exchanges,History — The Professor @ 8:12 pm

What party, you ask? The one with the mosh pit at LaSalle and Jackson in Chicago.  The one held in the building that’s in the background image of this page.

That’s right. Today the CME Group announced it was ending floor trading of futures (with the exception of the S&P 500) in Chicago and New York. Floor trading of options will continue.

As a Chicagoan who knew the floor in its glory days, this is a sad day. The floor was an amazing place. (Even though the floors will remain open until July, the past tense is appropriate in that sentence.)  A seemingly chaotic place full of shouting and gesticulating men (and yes, it was an overwhelmingly male place). Despite the chaos, it was an extraordinarily efficient way to buy and sell futures. In the bond pit in the 80s and 90s, $100,000,000 notional could be bought in sold with a shout and a wave. Over and over and over.

The economics of the pits were fascinating, but the sociology was as well. They were truly little societies. There were the exchange rules that were in the book, and there were the rules not written in any book that you adhered to, or else. Face-to-face interactions day after day over periods of years created a unique dynamic and a unique culture with its own norms and hierarchies and rituals. And soon it will be but a memory.

Even though I am wistful at the passing of this remarkable institution, I was ahead of the curve in predicting its eventual demise. I worked at an FCM in 1986, when the CME, CBT, and Reuters announced the initial Globex initiative. This got me interested in electronic trading, and when I became an academic a few years later, I researched the subject. In 1994 I wrote one of the early papers documenting that electronic markets could be as liquid and deep as floor-based markets, and I conjectured that parity in liquidity and superiority in speed and cost of access would result in the ultimate victory of computers over the floor. The collective response in the industry was scorn: everyone knew the floor was more liquid, and always would be. The information environment on the floor could never be duplicated on the screen, they said. This view was epitomized by the CEO of LIFFE, Daniel Hodgson, who ridiculed me in the FT as an ivory tower academic.

The first sign that the floor’s days were numbered occurred in 1998, when computerized Eurex wrested the Bund futures contract from LIFFE. (Eurex used my research as part of its marketing push.) LIFFE suffered a near death experience, barely surviving by shutting the floor and going fully electronic. (Mr. Hodgson was shown the door, and I resisted the temptation of sending him a certain FT clipping.)

Computerized trading was only slowly making inroads in the US at the time, in part because the incumbent exchanges resisted its operation during regular floor trading hours. But the fear of the machines was palpable by the mid-1990s. The CBT built its massive trading floor in 1997 in part because the members believed that if it spent so much on a new building the exchange couldn’t afford to render it useless by going electronic. Ironic that a group of traders who lived and breathed real world economics would fall victim to the sunk cost fallacy, and be blind to the gales of competition and creative destruction.

The floor continued to thrive, but inexorably the machines gained on it. By the early-2000s electronic volumes exceeded floor volumes for most contracts, especially in the financials. By the end of the first decade of the millennium, the floors were almost vacant. I remember going to the crude oil pit in NY in early-2009, and where once well over 100 traders stood, engaged in frenzied buying and selling, now a handful of guys sat on the steps of the pit, reading the Post and the Daily News.

When the CME demutualized, and when it acquired CBT and NYMEX, it made commitments to keep the floors open for some period of time. But the commitments were not in perpetuity, and declining floor volumes made it evident that eventually the day would come that the CME would shut down the floors.

Today was that day.

This was inevitable, but in the 80s and 90s the floor trading community, and the futures business generally, couldn’t possibly imagine that machines could ever do what they did. But the technology of the floor was essentially static. Yes, the technology of getting orders to the pit evolved along with telecommunications, but once the orders got there, they were executed in the same way that they had been since 1864 or so.* That execution technology was highly evolved and efficient, but static. In the meantime, Moore’s Law and innovation in hardware, software, and communications technology made electronic trading faster and smarter. Electronic trading lacked some of the information that could be gleaned looking in the eyes of the guy standing across the pit, or knowing who was bidding or offering, but it made accessible to traders vast sources of disparate information that was impossible to absorb on the floor. By the late-00s, HFT essentially computerized what was in locals’ heads, and did it faster with more information and fewer errors and less emotion. Guys that were all about competition were displaced by the competition of a more efficient technology.

Floor trading will live on for a while, in the options pits. Combination trades in options are complex in ways that there are efficiencies in doing them on the floor. But eventually machines will master that too. ICE closed its options pits a couple of years ago (four years after it closed its futures pits), and one day the CME will do so too.

The news of the CME announcement reminded me of something that happened almost exactly 10 years ago, 21 February 2005. Around that time, the management of  the International Petroleum Exchange was discussing the closure of the floor. (It decided to do so on 7 March.) Floor traders were very anxious about their future. Totally oblivious to this, Greenpeace decided to mount a protest on the IPE floor to commemorate the Kyoto Protocol. Bad decision. Bad timing. The barrow boys of the London floors, already in a sour mood, didn’t take kindly to this invasion, and mayhem ensued. Punches were thrown. Bones were broken. Furniture was thrown. There was much comedy:

“The violence was instant,” reported one aggrieved recipient of a rain of blows to the head. “I’ve never seen anyone less amenable to listening to our point of view.”

You can’t make that up.

From what I understand, the response was much more subdued in Chicago and New York today. But then again, Occupy or GMO protesters didn’t attempt to sally onto the floor to flog their causes. If they had, they just might have caught a flogging like the enviros did in London a decade back.

Being of a historical bent, I will look back on the floors with fascination. I am grateful to have known them personally, and to have known many who trod the boards in the pit in their colorful jackets, shouting themselves hoarse and at constant risk of being stabbed in the neck with a pencil wielded by a hyperactive peer.

Today is a good day to watch Floored or The Pit. Or even play a game of Pit. The films will give you something of a feel, but just a bit.

2015. The year Chicago lost Ernie Banks and the floor. But life moves on. Machines do not have the color of the floor, but they perform the markets’ vital functions more efficiently now. And not everything has changed in Chicago. The Cubs are still horrible.

*The exact beginning of floor trading on the CBT is unknown. The Board of Trade of the City of Chicago was formed in 1848, but futures trading proper probably did not begin until the Civil War. Sometime in the 1862-1864 period floor trading as we know it today-or should I say knew it?-developed. The first formal trading rules were promulgated in 1867. If you look at pictures from the 19th century or early-20th century, other than the clothes things don’t look much different than they did in the 1980s or 1990s. Electronic boards replaced chalk boards, but other than that, things look very similar.

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  1. Great remembrance, Prof. That barrow boys/IPE piece you linked to is a classic, but look at the closing price of oil cited at the end of the story — 10 years later it’s almost exactly the same. You, Sprecher and others saw the end of floor trading a long time ago, but who would’ve anticipated that?

    Comment by Steve — February 4, 2015 @ 10:19 pm

  2. Those IPE boys are legends.

    I thought the Egyptians invented floor trading? Wasn’t Joseph in the Bible a wheat backwardation player? He was found in a pit and wore a stripey coat.

    Comment by Green as Grass — February 5, 2015 @ 5:21 am

  3. …and when the front month spiked after seven years of contango he liquidated to the screen. Scroll. Papyrus.

    And he didn’t spare his brothers either. Business is business.

    I’m on a roll here.

    Comment by Green as Grass — February 5, 2015 @ 5:45 am

  4. The game Pit was a huge favorite in our household growing up. I remember we played it with an Italian exchange student the day after he arrived at our house (with associated jet lag) and his expression was like “WTF is wrong with you guys!” Great memories.

    Comment by Tom — February 5, 2015 @ 8:05 am

  5. Craig,

    Very poignant, indeed.

    I have very vivid recollection of my time on the floor of the CME (in Eurodollar options, next to Eurodollar futures and the S&P 500 pit).

    What is about options trading in particular that makes the pit still now better than electronic trading? Is the ability to trade spreads and ratio trades?


    Comment by John McCormack — February 5, 2015 @ 9:44 am

  6. Prof: I know you have plenty of other work on your plate, but I would really, really like to hear your take on the latest from Mike Masters, via Izzy Kaminska:

    Is this history revisionism, or what? Maybe he was right all along. I honestly don’t know what to make of his arguments.


    Steve Holt!

    Comment by Steve Holt — February 5, 2015 @ 9:48 am

  7. @Steve-Don’t get me started. But I probably will 😛

    Short version: he was wrong then. He is wrong now.

    The ProfessorComment by The Professor — February 5, 2015 @ 12:28 pm

  8. Hey…we don’t need a shoe clerk like you to write our obituary.

    And to all those cheering the Floor’s demise, I say get back in your holes you pathetic little worms and grovel for you paycheck….you probably wouldn’t have lasted a week in the Pit, and that’s if you were lucky.

    Comment by Pit Trader — February 5, 2015 @ 1:28 pm

  9. I would quibble a bit with your analysis. The German debt contracts weren’t a totally electronic vs open outcry situation. It proved that German debt could be traded by German banks on a German exchange-there was quite a bit of peer pressure and coercion on German market makers to trade Eurex vs Liffe. The Eurex also paid market makers to make markets, and subsidized their trading. Liffe was pretty cocky back then-and by the time it was time to fight it was too late.

    CME actively used its fee structure, its marketing department, and co-location to entice markets to the screen. The meat contracts at CME would still be pit traded if they didn’t do that.
    Additionally, CME compromised floor technology (handhelds) and made it very difficult on independent traders. They looked the other way when it came to charging fees on traders so they didn’t have to invest in seats. Even today, CME uses block trading, fees, and other means to try and make it difficult on options traders. They are increasing costs that aren’t fee related. There is uneven application of rules, and CME looks the other way when it’s electronic traders violating them. CME also publicly said, “we don’t care, we will trade either way”-but the private reality was very different. In CME’s own narration on the IPO, the management demonized the B share holders. One of the strategic reasons for this move is the quest to get rid of B shareholders on the board.

    That being said, no one has ever taken the time to really try and integrate open outcry with technological trading and have a true blended market. It’s entirely possible to do with the way tech is these days, but the financial incentive to build a better market isn’t there.

    The marginal volatility of trading today is far higher than it’s ever been. Contracts are more volatile-despite doing more volume. There is an illusion of liquidity. For small Johnny One Lot traders, it’s great. But for the old independent traders that need to move positions the slippage and cost of trading has skyrocketed. I have seen more violent intraday moves since the markets went computerized than I ever did on the floor-and I floor traded from 1988-2011. It’s not sour grapes, other long time trades I know have said the same thing that are still in the business. I have moved on, and am raising an early stage VC fund at Check it out.

    The industry always changes. That’s not bad or good-it’s different. But, I think the analysis that I have seen in the newspapers on this issue is very over simplified. This wasn’t bank tellers vs ATMs. I blogged about the floor today at

    For the record, I was one of the guys that lead the fight to bring technology to the CME in the 1990’s. It was a bloody battle. Jack Sandner and his people fought us tooth and nail every step of the way. Leo Melamed never got on board until he saw we had a chance. Bill Shepard lead the charge, along with Joel Stender, Don Karel, Aryeh Shender, Yra Harris, Craig Norris, Irv Rosen, Buck Hayworth and others. I was a part of that crowd. I can guarantee you that the exchange doesn’t look like we envisioned back then.

    Comment by pointsnfigures — February 5, 2015 @ 1:54 pm

  10. The move to electronic trading was inevitable, but one big thing that accelerated it was when Cantor lost so many of its voice brokers handling interest rates on 9/11. There was no way the collective abilities of those individuals could be replaced and Lutnick knew the only way the firm would survive was by concentrating on electronic trading. The currency guys had been doing electronic trading for a while, the younger crop of energy traders pretty much knew nothing but electronic markets because of Enron Online and interest rates were electronic. By 2002 everyone knew electronic markets were destined to rule the world except the guys at NYMEX.

    Comment by Charles — February 5, 2015 @ 2:09 pm

  11. “Cantor Schmantor, but it is a sad day none the less.

    Comment by TomHend — February 5, 2015 @ 4:37 pm

  12. @pointsnfigures-I’m familiar with the other aspects of LIFFE’s near death. I wrote about them in a paper called “Bund for Glory, or, How to Tip a Market.” You are right that LIFFE was cocky. It was the hare in the hare and the tortise story. It rested on its large lead. In particular, when Eurex cut fees to zero, LIFFE did not match. The markets were already close enough in terms of liquidity that the fee cut made it cheaper to trade Eurex, and then LIFFE began to hemorrhage volume. It eventually cut fees, but too late.

    The CBT learned a LIFFE lesson. When Eurex tried to compete in Treasuries in 2003, and offered various volume incentives, CBT immediately slashed fees and Eurex never got off the ground.

    Insofar as subsidizing liquidity is concerned, this is the only way for an entrant to compete against a well-established incumbent. Every exchange that I am aware of has provided market making/liquidity incentives when it attempted to compete against an incumbent.

    Put differently, incumbent markets have a huge built in advantage. That’s what made the Eurex-LIFFE case so stunning. It wouldn’t have happened the way it did without LIFFE’s arrogance.

    Insofar as volatility and liquidity are concerned, the empirical evidence doesn’t support your claim. It is clear, though, that small traders do relatively better in an electronic market.

    Insofar as technological change goes, I also observed, though at a greater distance, the Luddism of CME, and especially CBT. CME was Buck Rogers compared to CBT. And it is almost always the case that things don’t turn out quite the way innovators anticipate. They are disrupters, but can’t control the consequences of their iconoclasm.

    The ProfessorComment by The Professor — February 5, 2015 @ 5:21 pm

  13. […] Pirrong wrote a great blog post on the CME closures. Check it out here (website) or […]

    Pingback by CME Ends Open Outcry Trading of Futures in New York and Chicago : The Deep Estate — February 5, 2015 @ 6:39 pm

  14. Enjoyed your comments of an era gone by. I am a bit nostalgic, as I traded as an independent local in the bonds in the glory days for 20 years. It was sometimes tense but exhilarating experience each and every day. The vast majority were stand up traders with a solid code of ethics.
    It was an amazing place that provided unique opportunities for those willing to work hard and remain disciplined.

    Comment by Stu — February 5, 2015 @ 8:44 pm

  15. “it was an extraordinarily efficient way to buy and sell futures”

    Umm, you realize that this is completely untrue, don’t you? Its inefficiency is the reason the whole thing got shut down.

    Comment by John S. — February 6, 2015 @ 2:20 am

  16. Enough reminiscing about pits and screens… what is next for futures trading? We have about hit the limit for HFT in terms of time granularity, but there are huge opportunities in cross-market products, exotics and liquid geographic basis markets. The geographical nature of physical futures contracts seems like an anachronism compared to global commerical trade.

    My prediction.. and looking for other other wild ideas in SWP readership. The CME focuses on maintaining their government franchise of operating a CLOB- and all futures trading moves to a decentralized model- similar to the decentalized FX spot market. A network of dealers maintain liquidity 24/7, diverse geography for physical deiivery in Ghanzou or Seattle,and fast liquidity pools of RFQ exotics, rather than specific contracts with a single strike, exchange-defined maturity and warehouse location. Futures trading goes from 100s of cleared contracts, to billions of structured derivative products. A million flowers bloom, and CME rent from S&P futures contracts dries up to a trickle.

    Comment by scott — February 6, 2015 @ 6:29 am

  17. Scott

    How does the clearing work in that scenario?

    The goal of regulation – certainly in Europe – is for there to be **no** financial markets, not more.

    Comment by Green as Grass — February 6, 2015 @ 7:47 am

  18. @John S. Umm, you realize the sentence is in the past tense?

    The ProfessorComment by The Professor — February 6, 2015 @ 1:25 pm

  19. @Green & @Scott-With this liquidity ratio madness even the futures markets, which were regulators’ golden children compared to those damnable OTC markets, are under serious threat.

    The ProfessorComment by The Professor — February 6, 2015 @ 1:30 pm

  20. just realized something that I should have seen immediately. CME is shutting futures pits down-but options pits remain open. They won’t save any money and admitted it might only be a measly $10M to their bottom line. They spend more than that on the parties they throw every year and their LPGA sponsorship.

    Anyway, this is really a shot at the B shareholders. A group is suing CME, and last year they moved to try and get them off the board. At the meeting, CME ordered a heavy Chicago police presence. CME mgmt has always mistrusted floor traders, and has a huge disdain for them. CME has moved to try and devalue B shares, and even set up ways for electronic traders to circumvent traditional fee structures.

    This is more about the fight between B directors, B share fees, and depressing the value of B shares in case they have to buy them out. It’s not Futures going electronic.

    Comment by pointsnfigures — February 7, 2015 @ 1:38 pm

  21. what’s the title a reference to?

    Comment by fm — February 7, 2015 @ 1:50 pm

  22. @fm-It’s an old Willie Nelson song. Don Meredith used to sing it when the outcome of a Monday Night Football game was no longer in doubt.

    The ProfessorComment by The Professor — February 7, 2015 @ 3:00 pm

  23. […] […]

    Pingback by Weekend Reading XCXVII : Blogcoven — February 13, 2015 @ 6:34 am

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