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How Futures Exchanges Work

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In this chapter from The Complete Idiot's Guide to Options and Futures, you will be shown how the exchanges work, who is on the trading floor, how your orders flow through the process, and more. Learning this will help you understand how the system operates if you decide to participate in it.
This chapter is from the book

In This Chapter

  • Life in the pits ... exchanges and their role

  • What is all that yelling and screaming about?

  • Types of floor traders

  • Order flow from customers to pits

  • Free markets and open outcry conclusions

Futures exchanges provide a centralized location for buyers and sellers to meet, and through an open outcry auction process, discover a price for a specific futures and or options contract. The exchanges are also responsible for disseminating these prices and guaranteeing fulfillment of traded contracts.

The larger trading floors in the United States are the Chicago Board of Trade, Chicago Mercantile Exchange, and New York Mercantile Exchange, and the smaller regional exchanges are the Kansas City Board of Trade and Minneapolis Grain Exchange. Everyone has indirect access to the trading floors of the world through their brokers; only exchange members have the privilege of actually trading on the floor of the exchange proper. Each exchange is unique in size, shape, governing principles, and rules, but all the exchanges in the United States have a few common characteristics.

Inside this chapter, you will be shown how the exchanges work, who is on the trading floor, how your orders flow through the process, and more. Learning this will help you understand how the system operates if you decide to participate in it.

Trading Lore

Though Chicago was the birthplace of the futures industry, a great amount of rivalry exists between the two exchanges. For example, members of the Chicago Board of Trade refer to Chicago Mercantile Exchange members as "Merc Jerks," while the Chicago Mercantile Exchange refers to the Chicago Board of Trade as the "Board of Thieves." The rivalry between the exchanges is similar to the rivalry between baseball fans ... don't even get me started on why the Cubs are a better team than the White Sox.

Where It All Happens

Exchange members stand in octagonal and/or polygonal trading pits or rings, with steps descending to the center of the pit. Traders stand in groups inside the pits according to the contract month they are trading. Buyers and sellers stand throughout the pit, as any trader can be a buyer or seller at any given moment. They communicate with each other through their booming voices and hand signals developed to communicate what they are buying or selling (quantity, contract month, and price). In most cases each pit trades a particular commodity.

Adjacent to the trading pit (or sometimes in its center) are market reporters who are employed by the exchanges to record price changes as they occur (refer to the section Order Flow from Customer to Pit later in this chapter for more information). The recorded prices are then displayed on computerized display boards. These prices are also sent outside the exchanges to more than 50 different vendors of financial information, who in turn retransmit the information in a variety of different formats to hundreds of thousands of different subscribers. This important function of the exchange, where prices are arrived at on the floor of the exchange but disseminated to the world, is known as price transparency.

The exchanges on the Web are as follows:

  • www.cbot.com—Chicago Board of Trade—Trades Corn, Wheat, Soybean Complex, Treasury Bonds and Notes, and the Dow Jones Stock Indexes.

  • www.cme.com—Chicago Mercantile Exchange—Trades Eurodollars, S&P Stock Index, NASDAQ Stock Index, Cattle and Hogs, Foreign Currencies, and Lumber.

  • www.nymex.com—New York Mercantile Exchange—Trades Gold, Silver, Platinum, Palladium, and Petroleum Products (Crude Oil, Heating Oil, Gasoline).

  • www.csce.com—Coffee, Sugar, Cocoa Exchange—Trades Coffee, Sugar, Cocoa.

  • www.kcbt.com—Kansas City Board Of Trade—Trades Wheat and Value Line Stock Index.

  • www.mgex.com—Minneapolis Grain Exchange—Trades White and Spring Wheat futures.

The futures exchanges allow the world to know what the specific commodity—based on the futures contract—is trading at anytime during the exchanges' operating hours.

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