Chicago Mercantile Exchange (CME Group)

The Chicago Mercantile Exchange (CME Group) is a publicly-traded derivatives-based exchange (NasdaqGS: CME) founded in 1848, and based in the United States.

Being the first exchange to introduce forward contracts, standardization in futures trading, and the clearinghouse mechanism, the exchange has evolved into an important risk-management facilitator for a diverse set of participants trading in a wide range of asset classes.

Originally a non-profit organization at inception, the CME Group (formerly known as just the CME) eventually went public on in December 2002.

A merger with the Chicago Board of Trade (CBOT) took effect in July 2007 to form The CME Group.

On August 18th 2008, a subsequent merger was formally approved between CME Group and the New York Mercantile Exchange (NYMEX).  The current Chief Executive Officer (CEO) is Craig S. Donohue.

The CME Group provides forwards, futures, and options contracts on products and financial instruments across key asset classes such as Agriculture, Energy, Metals, Equity, Treasuries and Interest Rates, Exchange Rates, Real Estate, and even the weather.

Currently, the CME Group is the largest futures exchange in the world in terms of number of contracts outstanding (or open interest).

FUNCTIONS AND ROLE

The CME Group plays a significant role in supporting efficient markets in several key products and serving the risk-management needs for investors and corporations. Some of its main functions, roles, and uses include:

  • Standardizing the trading  in derivatives contracts
  • Allowing price discovery and providing liquidity
  • Permitting hedging (and speculation) against price fluctuations in key assets
  • Acting as a clearinghouse for derivatives transactions
  • Providing diversification and risk-management tools

TRADING PROCESS

There are two principal methods of trading on the CME exchange: Open Outcry and Electronic Trading (CME Globex)

OPEN OUTCRY

The open outcry method of trading involves verbal and non-verbal communication on a physical trading venue called the trading floor (or the pit).  Typically, traders and brokers use shouting and using hand signals to communicate buying/selling intentions or motivations.

CME GLOBEX TRADING PLATFORM

Electronic trading is the backbone of over 70% of transactions conducted on the exchange.

The CME Globex platform allows traders across the globe to access thousands of futures and options contracts on a virtually 24-hour basis.

Faster, more efficient, and less costly than open outcry, CME Globex offers real-time data, high speed, and high-volume capacity trading.

The CME is an electronic order-driven market (basically an auction market).

In such a system, trading rules are set in such a way where buyers enter orders seeking the lowest price, while sellers enter orders seeking the highest price.

This price-discovery process is made possible by an electronic order-matching system that follows certain trading rules.

Such rules play an important role in providing liquidity and ensuring an orderly price-setting mechanism that is conducive to efficient markets.

 

 

 

 

 

 

TYPES OF SECURITIES TRADED

The following table presents some of the most popular and heavily traded contracts covering some major asset classes. Trading is executed amongst the CME Group merged members (CME, CBOT, NYME).

AGRICULTUREENERGYEQUITYBONDS/INTEREST RATESFX
Grains& Oil SeedsCrude OilUS Index Fut and Options STIRG-10
CornCL Light Sweet Crude OilE-mini S&P 500 (Dollar)EurodollarAUD/USD
WheatCVF Crude Oil Volatility IndE-mini S&P 500 (Euro)OPTMid-CurveAUD/CAD
SoybeansOil (WTI) FinancialE-mini S&P MidCap 4001-month EurodollarAUD/JPY
Palm OilBZ Brent Crude OilE-mini S&P SmallCap 600Euroyen TIBORAUD/NZD
LivestockEthanolE-mini NASDAQ-1003-Month OISCAD/USD
Live CattleEH EthanolS&P 500/ValueEurodollar Calendar SpreadCAD/JPY
Lean HogsNatural GasS&P 500/GrowthUS Treas. Fut and OptionsCHF/USD
Feeder CattleNG Natural GasTechnology SPCTR13-week T-billCHF/JPY
Dairy Henry Hub Natural GasIntl Index Fut and OptionsUltra T-Bond FUTEUR/CAD
Class II MilkElectricityE-mini MSCI EAFE2-Year U.S. Treasury NoteEUR/USD
Dry WheyPJM Western Hub PeakNikkei 225 (Yen)3-Year U.S. Treasury NoteEUR/AUD
PowderU6 ISO New England TermFTSE/Xinhua China 255-Year U.S. Treasury NoteEUR/GBP
SoftsRefined ProductsE-mini MSCI Emerging Markets10-Year U.S. Treasury NoteEmerging Mkts
CocoaHeating OilETF FuturesInterest Rate IndexesBRL/USD
CoffeeRBOB GasonlineS&P Depository ReceiptsU.S. Aggregate Bond IndexMXN/USD
Forest7f European GasolinePowerShares QQQEurozone HICP FuturesZAR/USD
LumberCoalTRAKRSSwapsRUB/USD
PulpCentral Appalachian CoalTRAKRS PIMCO CRRDJ CBOT Treasury IndexRMB/USD

 

CLEARINGHOUSE MECHANISM

The CME also provides an important risk mitigation function with respect to its clearinghouse mechanism, basically providing clearing and settlement for derivative transactions.

By imposing margin requirements on the counterparties (buyers and sellers) of derivates transactions, credit and default risk is minimized.

Through a marking-to-market process, gains and losses arising from positions taken in contracts are settled on a daily basis, with margin requirements adjusted accordingly.

A hypothetical example will illustrate this procedure. The numbers are purely arbitrary and do not represent actual contract prices or margin requirements:

  • A futures contract is purchased (long position) for a total value of $5,000.
  • In order to trade the contract, the CME could for example set up the following parameters:

 

(1)   an initial margin of $4,000

(2)   a maintenance margin of $3,000

 

  • If the value of the contract falls below $3,000, the trader will have to deposit money into his account to bring his margin back to $4,000.
  • Furthermore, all daily gains/losses arising from price fluctuations are settled daily in the account.

 

REGULATION

All derivative transactions on the CME are regulated and supervised by the Commodity Futures Trading Commission (CFTC), which was created in 1974 by the US Congress as part of its amendment to the Commodity Exchange Act (1936).

Its main mission is the protection of investors and the public from fraudulent and manipulative trading practices, and to promote sound futures and options markets

In 1982, the futures industry created the National Futures Association (NFA), with the aim of being an independent self-regulatory organization.

 

CONCLUSION

The CME Group is an order-driven exchange that facilitates the trading of forward, futures, and options contracts on numerous products within key asset classes such as agriculture, energy, metals, equities, interest rates, and exchange rates.

It also plays a key clearinghouse role in margining and marking-to-market transactions, effectively mitigating the credit and default risk of counterparties involved in trading derivatives.

Over the years of its existence, it has largely moved from a purely open-outcry physical trading facility into an electronically-based trading exchange.

 

Keywords: CBOT, Options, Futures, Derivatives Exchange, Clearing-House, Margin,