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The Changing Face of Commodity Trading

posted on April 11, 2014

Longtime viewers of this program know that we always quote FUTURES prices on Market to Market. While our analysis also explores ramifications for CASH marketers, the bulk of our analysis relies on data from futures exchanges in Chicago.

Since 1848, open-outcry was the only method of trading at the Chicago Board of Trade, or CBOT. With arms flailing and voices blaring, frenzied traders haggled over prices, and orders were filled with a few hand signals, a nod or even a shout.

But things changed dramatically in 2007, when the Chicago Mercantile Exchange and the Chicago Board of Trade merged to form the CME Group – the world’s largest and most diverse trading exchange.

Computerized transactions soon emerged as the dominant method of trading. But even in today’s modern markets, there are still guys in rather colorful jackets doing business the old fashioned way.

The Changing Face of Commodity Trading

Shouts can still be heard on the floor of the Chicago Board of Trade at 141 West Jackson but nothing in comparison to the cacophony of the past. Most of the open outcry trading has left the futures ring and now takes place in the options pit. The rest of the action at the world’s oldest futures exchange has been reduced to a little more than a mouse click.

Scott Shellady, Bull Reef Brokerage: “It used to be an advantage when we had all the open outcry transparency held down here where we could see the information, then we had the knowledge.  But now sometimes things happen and there's much more information floating around electronically where we're the fly on the windscreen per se. And we're the last guy to know, “ 

Scott Shellady has been a commodities trader for more than 25 years. A second generation floor trader, Shellady owns one of the 3,600 seats, or memberships, on the CBOT allowing him to trade on the floor. Memberships come with various trading rights on the exchange but only 1,400 are considered to be “full seats.” The price of a seat hit an all-time high of $3.2 million in 2006 but prices have declined 92 percent over the past 8 years to $265,000. And Shellady says the reasons for owning a seat have changed dramatically.

Scott Shellady, Bull Reef Brokerage: “...So maybe for actually trading costs at the exchange level it is an advantage, we trade at a cheaper price as far as the tax that we pay the exchange.  But other than that, where it used to be something as an advantage for information, it's not anymore.”

These days, Shellady does nearly all of his business electronically, which allows him to trade more than just agricultural commodities. However, he does note the advantages and disadvantages of both spending time in a desk chair and shouting in the trading pits.

Scott Shellady, Bull Reef Brokerage: “...because the customers want both things, they want trade certainty.  Am I filled?  Am I filled?  Am I done?  Am I done?  Have I done the actual, has my broker executed what I want him to do? ...So if I do that in the open outcry market I can tell them what everybody else is doing ...  Or I can tell them upstairs electronically yes you're done, I've done what you wanted me to do.... So, for speed you lose -- speed is less transparent.  Slower is more transparent. So there's a give and a take on both of those if you understand what I'm saying.  So we can all see what everybody is doing a little slower and disseminate that information or we can do it really fast upstairs and nobody knows what anybody is doing.”  

The first electronic trades were made in 1992 on the CME Globex trading platform. Use of the program was limited by computing power and bandwidth. Today, those hurdles have largely been overcome making it possible to buy and sell anywhere a data connection is available.

According to the CME Group, more than 90 percent of agricultural futures and nearly 55 percent of agricultural options transactions are no longer executed in the commodity pits. The trend can be seen across the entire exchange as the number of people in the grain and livestock rings diminishes.

But, as the number of people trading on the floor has declined the number of opportunities to make trades has increased. In April of last year, the 165 year-old Exchange combined the traditional 4 hours of open outcry with 17 hours of simultaneous electronic trading. The new hours allowed the CBOT and CME to reach a volume of more than 265,000,000 futures and options contracts in 2013. This is down 8 percent from the heavily drought influenced record trading year of 2012.

Jack Scoville, PRICE Futures Group: “I can remember after the close of the grains on any given day you could go downstairs to the bar or up to your office and sit around and talk ... about corn, soybeans and wheat for a couple of hours, just soaking up knowledge and comparing notes.  We can't really do that anymore.  I think that has been the big loss and I'm sorry to see that part of it go.  On the one side I can get quicker and better and cleaner executions for myself and my customers. But on the other side I've lost access to a lot of knowledge that is very, very hard to replace.”

Jack Scoville began as a runner on the Chicago Board of Trade in 1981 and worked his way up to being a floor trader. Scoville left the trading ring in 1990 and has been trading electronically for the PRICE Futures Group since 1992.

Jack Scoville, PRICE Futures Group: “It's a tough decision.  The open outcry is a lot more fun, a lot more action, a lot of excitement that you don't really get sitting here in an office. ...We can trade with much more certainty.  When we get a filled price, we know it's a filled price.”

While Scoville laments the loss of comradeship in the trading ring he does point up the advantages of the new trading landscape.

Jack Scoville, PRICE Futures Group: “I can remember 30 years ago when I was having to call Brazil for the company I was working at, at the time, and it could take me a half hour to get a phone line. And then I’d have to try and keep it open all day long. Now, I can just call the guys up from wherever I am around the world. I can tell you that I’ve spent time riding in the back seats of pickup trucks in Central America passing orders from Brazil to Chicago for my clients.”

The CME Globex electronic trading platform also allows for some traders to make a large number of trades in millionths of a second. CME officials have yet to break out how much of the trading volume is made via the practice of high-frequency trading and they are quick to point out that the most important thing is the integrity of their markets for each and every participant.

How and where all the information is gathered and used has changed. In the past, floor traders reacted to the peaks and valleys of various trading cycles. They would often trade in ways that are sensitive to harvest lows, weather trends and key government reports. But with all the information readily available on the internet, tech savvy traders can shift the market in unexpected directions.

Scott Shellady, Bull Reef Brokerage: “So there may be a trader in India that doesn't know about those cycles and so they'll trade against them and if you have enough people doing a one lot trade that can be a big trade.  And if it just so happens they all do it at the same time you might see there's rain on the horizon for corn, corn prices should be going down but enough people have bought a one lot from somewhere else in the world that the market is rallying.  So we have to be careful about what is actually happening... slowly but surely somehow take the noise out.

And as more and more commodities on the CME Group are traded electronically, Shellady believes it is important to balance knowledge and experience against the pressure of changing times.

Scott Shellady, Bull Reef Brokerage: “You could shoot a cannon through here and not hit anybody.  So it's nowhere near what it used to be and ultimately that's not the exchange that decided or the traders to decide, the customer will decide when and if he or she wants to do the business 100% electronically.  But right now there's enough customers that do call people and we execute in the pit.  So as long as that's the same it'll still stay open.”

For Market to Market, I’m David Miller.

Tags: Bull Reef Brokerage CBOT CME Group electronic trading Jack Scoville PRICE Futures Group Scott Shellady