It’s 8:28 a.m. on a Monday in early March, two days after Russian president Vladimir Putin has gained parliamentary approval to invade Crimea. Russian troops have rooted themselves in Crimea, and Ukraine has called up its reserves.
Scott Shellady and a cluster of traders in the corn options pit at the Chicago Board of Trade (CBOT) are quiet, waiting for the markets to open. Shellady and his colleagues have been here since 5:30 a.m. because Putin’s manoeuvres are sure to ricochet through the markets.
Shellady, the son of a trader and dairy farmer, has been at this for 26 years, and he wears his heritage on his back, in the form of a Holstein-print jacket, just like his father used to wear on the floor.
Ronald Shellady wore the cow-print jacket as a reminder that floor traders serve a function, his son explains. “So it’s not dollar bills in Vegas. There’s a guy that’s got cattle and there’s a guy that’s got grain, and we’ve got to put the two together somehow and sell his milk and sell his corn. So that’s why he wore it.”
“So it’s kind of like a game-used jersey. I wear it now.”
Rows of computers for support staff and electronic traders circle the pits. A Sons of Agriculture sticker, spoofing the Sons of Anarchy series on HBO, marks one terminal. Huge screens of numbers, flashing green, orange and red, border the room. CNBC plays out on enormous flat screens.
In the middle of the floors lie the pits, sloping towards the centre, calling to mind amphitheatres. We all wait for the show to start.
The New York Stock Exchange has an elaborate ritual each morning, Chris Grams, the CBOT director of corporate communications tells me. In New York, companies pay for the honour and bring in celebrities to ring the opening bell at 9:30 a.m., as they’ve done for decades. But Chicago’s trading community hasn’t any desire for such ceremony, it seems.
Chicago is all business. Exactly at 8:30 a.m., a low buzzer sounds, and at that moment, the corn options pit erupts into shouting and flailing hand signals. Adrenalin and testosterone permeate the air like humidity. For a first-time visitor, it’s a striking scene.
Yet the grain floor isn’t nearly as hectic as it used to be. Before the advent of electronic trading, each pit would have been a jostling sea of traders, aggressively wheeling and dealing. Today the futures pits feel like ghost towns to older traders.
Algorithm-based trading is affecting not only the number of traders, but the very culture of the people working in and around the exchange, raising questions about whether Chicago can still perform its price-discovery function.
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It’s worth delving into the Chicago Board of Trade’s past to better understand the changes it’s caught up in today.
Farmers and merchants began gathering in Chicago in the 19th century to trade. “There were merchants on every corner at harvest time, so the farmers would come in and talk to a merchant or two, but they were scattered all over the city,” says Fred Seamon, senior director of ag commodity research and commodity development with Chicago Mercantile Exchange (CME) Group.
Seamon spends his days levelling the playing field so the game is fair for both buyers and sellers. “I’m one of the few people who can say that my job is to make all of our customers a little unhappy because that means they don’t have an edge in the market.”
In 1848, a group of businessmen decided to centralize the merchants to bring in price transparency and so everyone could participate in price discovery, Seamon says. “And immediately things got better because everyone knew what was going on.”
Storage facilities were built so grain could be sold when it was worth more, giving the industry some price risk management. “You could lock in a price today, and no matter what prices did, you were protected. And that sort of evolved to futures,” Seamon explains.
The Chicago Butter and Egg Board, the CME’s forebear, formed in 1898 to offer contracts in those commodities. In 1919, the board’s mandate expanded to futures trading and it morphed into CME. In 2007, the CME and Board of Trade merged into CME Group. Today CME Group offers trading in metal, energy, currency and agricultural commodities, and also includes markets in New York and Kansas City.
The historic section of the Board of Trade building, an art deco skyscraper, was finished in 1930 and stands in the heart of downtown, at 141 W. Jackson Boulevard. The Roman goddess of agriculture, Ceres, adopted as a sort of patron saint by corn traders, still perches at the scraper’s peak, clutching a grain sample bag in one hand and a wheat sheaf in the other. She surveys her domain with, one imagines, a mixture of benevolence and wrath.
But even with that pride in the Board of Trade’s history, change is inevitable, and no one knows it better than the analysts and traders working in and around CBOT.
Loss of knowledge
Back in 2006, CBOT launched electronic trading. Today more than 80 per cent of all CME Group trades are electronic, which has led to fewer boots on the floor. In 2008, CME Group merged the remaining open-outcry traders to a single floor in the historic Board of Trade building.
Jack Scoville started as a runner on the CBOT floor in the early ’80s. Today he’s a futures market analyst and vice-president of PRICE Futures Group. He doesn’t work on the floor these days, but sits at a computer, one in a row of five. He chats with clients through Skype, with a landline and cell phone also at hand. Orchids rest between his and his neighbour’s work stations.
Scoville specializes in grains, softs, rice, oilseeds and tropical commodities such as coffee and sugar. His day typically starts at 7 a.m., when he checks the previous day’s runs and publishes his market commentary for clients, in English and Spanish. But his day doesn’t wrap at 5 p.m. — night sessions open at 7 p.m. and he works Sunday nights, too.
Scoville seems relatively relaxed, but throughout our conversation he keeps an eye on his computer screen, watching the markets.
“These were both down, coffee and sugar, when I walked in, but they’re up big time now,” Scoville says.
The floor was a little wilder when Scoville started out. “You’d see fights every once in a while.” He recites some of the arguments that preceded fisticuffs in the pits.
But as future trades have moved online, CBOT has lost more than the thrill of the occasional brawl. The futures traders have left the pits, and are trading for themselves at home or have taken on other jobs, Scoville says.
“That central meeting place for knowledge is not really there. It’s a real shame,” says Scoville.
A block north of CBOT, on South LaSalle Street, Jerry Gidel works as the chief feed grain analyst at Rice Dairy. He has a strong grasp on the fundamentals, and chats about everything from the weather and drought patterns to Canada’s grain transportation system and dried distillers grain.
Russia’s move into Crimea has Gidel scrambling today, too, as he revises his weekly market updates, which go out on Tuesday.
Like Scoville, Gidel started working on CBOT’s grain floor in the ’80s, and he says there used to be people around the Board of Trade whose work with elevators and producers gave them a better understanding of grain markets. However, the expansion of electronic trading to speed order flow has wiped out this floor pit community, he says.
“The speculative community is now totally technical in orientation. It doesn’t really have a sense of some of the fundamentals,” Gidel says.
Gidel adds that the short-term traders, previously called locals, who used to populate the futures pits had a better sense of market fundamentals that made them less reactive to chart patterns and more attuned to fundamental news of the day.
When the floors were more active, locals tendered a bid and offer. They’d buy quickly and then immediately sell “one tic higher,” says Seamon. “And if they were right 51 per cent of the time, they could make a middle-class life doing that.”
Firms now do the same thing electronically, and are often referred to as high-frequency traders, Seamon says. “But they basically take the strategy that the local used to do on the floor and perform that strategy on the screen.”
Today’s high-frequency traders tend to focus more on the technical than fundamental side of agricultural markets, Gidel agrees. They lack a good sense of the seasonal nature of agricultural markets.
They also rely on algorithms set to follow five-minute charts, so “if the five-minute chart says to sell it, well then everybody sells it,” says Gidel.
“Sometimes I call them all lemmings because they don’t really follow the news. They follow the other followers,” Gidel adds. “So they’ll walk right off the edge of the cliff because that’s what all the lemmings are supposed to do. Because that’s what we’re all doing.”
High-frequency traders look less at statistics such as the Relative Strength Index (RSI) and more at moving averages, Gidel says.
“To me, that’s caused more volatility as we move dramatically from one moving average to the next,” says Gidel.
But despite a few warts, electronic commodity trading is now here to stay, says Gidel. For one thing, it allows people to move in and out of the market more easily, he adds.
Before electronic trading, anyone trying to buy at the low of the day had a tough time getting it filled, he explains. “In the electronic world, you’ve got a fighting chance if you happen to be buying at the bottom of the day.”
Shellady misses the open outcry, noting “you’re getting increasingly used to listening to the air conditioning upstairs in the office rather than being down here screaming and wearing a funny-coloured jacket.”
But customers want trade certainty, Shellady says. “You can give it to them instantaneously with an electronic screen. You lose some transparency, but at the same time you can also do more volume. There are some pluses and minuses to everything.”
Gidel adds the market needs the liquidity the high-frequency traders provide, too. “Otherwise you’re going to have the commercials overriding the markets. And so then you have a one-sided market, too.”
CME’s research indicates the market’s liquidity has improved over time, Seamon says. “You’ve got all of these traders that are competing to fill orders.”
The Commodity Futures Trading Commission collects data on who owns open interest. “The make up of the grain markets has remained remarkably constant through time,” Seamon says.
Electronic trading has significantly boosted the number of traders, Seamon says, but it hasn’t altered the market’s overall balance. “We’ve attracted new speculators, but we’ve also attracted new commercial participants for hedging. And that’s where a lot of our growth has been, in international participants being able to use these markets to hedge risk.”
Seamon also looks at hedging effectiveness or correlations with international prices, and he says those numbers have improved as well, probably because more global participants mean world events in remote agricultural areas are instantly reflected in prices.
Electronic trading has also changed CBOT’s culture to some degree. Relationships were important with open-outcry trading because, although anyone could place an order, only exchange members could trade on the floor, Seamon says.
“So those guys all relied on one another to make their living. So if someone tried to do something a little ethically challenged, they would get called on it because it requires co-operation among all of them,” Seamon explains.
More market regulations have replaced the standard of collegial accountability that brokers used to hold each other to, Seamon says. And electronic trading leaves an audit trail with each trade, he adds, making it fairly transparent.
Scoville says relationships are still important in his job. In fact, with the way the markets move these days, knowing your customers is more important than ever, he adds. “You’ve got to make sure your guy can handle it.”
What the next 10 years hold for electronic trading is anyone’s guess. Gidel thinks high-frequency traders may get tired of being burned by the market and educate themselves. Whether one looks at the stock market, bonds or commodities, “if you’re not going to be a part of the market, and you’re just going to sample that market, then, yeah, you’re going to get yourself kicked around,” he says.
Open outcry still king for options
Back on the floor, paper litters the floor outside the pits like snow. Chris Grams explains the traders in the pit don’t want to risk missing a deal, so they toss the paper and CME Group cleans it up at the end of the day. It’s visible evidence that although electronic trading has emptied the futures pits, so far open-outcry trading is still king for options, at least in Chicago.
“I think that they’ve had trouble getting the algorithms right in the computer programs to handle some of the more complicated option spreads,” says Scoville. “Futures is basically buy and sell it or buy May, sell July.”
The New York Mercantile Exchange, which also falls under CME Group, ended open-outcry trading for options. Scoville says he hasn’t tried an options spread in New York for a while because they’re hard to make work, particularly for coffee.
“I really like having the guys on the floor,” says Scoville. “We’ve got a couple that we work with rather specifically here in our office that we’ve known for years and trusted on the floor. And they’ll take our paper and give us a good shot.”
Options in Europe and Asia are also traded electronically these days, Shellady says. “But the U.S. customer still seems to like an open-outcry pit so far. It’s dwindling, though.”
The persistence of open-outcry trading in Chicago is partly because the exchange is run by members, Shellady says. “A lot of the other exchanges around the world are run by five banks so they can just make the decision on a Friday. So they made the decision for the customers.”
Whether or not customers will keep supporting open outcry trading for options in Chicago remains to be seen. “Maybe there’s a niche, maybe there’s not,” says Shellady. “But if it does ever go that way, it’ll be sad because it’s been a lot of fun and I’ve been doing it for 26 years. And it was neat.”
Shellady is gracious about answering questions, but it’s clear he’s busy this morning. As the interview wraps, he leaps back into the fray with a roar.
“I’m still at a quarter!”