The protest by Chicago Mercantile Exchange floor traders last Friday over privately negotiated block trades in Eurodollar options, is still simmering but so far it’s tilting in favor of the dark.
Yesterday, Leo Melamed, former head of the CME who is considered the creator of financial futures, defended the CME’s Eurodollar rules when he told reporters at a derivatives conference that block trades could not be handled in the open outcry trading pits, according to a Reuters story.
Melamed said CME must allow large trades to be executed away from the broader market because they “cannot be done just like that in the pit.” The market will be “carried away” from the large trades if they are executed on the floor,” instead of privately negotiated. the CME’s chairman emeritus, told reporters.
Melamed is also the brains behind Globex, the CME’s electronic trading platform, which encountered opposition from open outcry floor traders when it was first proposed, and today accounts for the vast majority of trading in futures and options. But apparently 90 percent of the trading in Eurodollar options is taking place in the open outcry pit.
Floor brokers have been called ‘dinosaurs’ and cry babies by various traders in the blogosphere. However, they are important intermediaries since they help banks and hedge funds transact in derivatives by using the Eurodollars to speculate or hedge against interest rate movements.
However, some commentators to a recent Bloomberg story insist that the floor locals are not on the side of the customer, that they would break up the trade, offer a lower price for 1/10th of the trade, which would cause the offer price for the customer "to jump higher" on the remainder of the trade.
Meanwhile, the CME is not changing its policies as it contends that the block trades were conducted within its rules. According to media reports, The CME’s policies allow for block trades to be privately matched away from the market, but they must exceed exchange size limits and be reported to the exchange within minutes. The CME may not want to alienate the block traders who are influential and can take their volume to OTC markets.
The floor brokers are upset because they didn’t get to participate in the trade. But it was more than that. The walkout is also about transparency. After these big Eurodollar trades were matched, the block trading participant was able to come to the floor and presumably hedge its position, before the block trade was publicly printed to the tape. So while the rest of the market was still in the dark, a customer or trading firm was able to take advantage of liquidity on the floor. There’s the rub!
There is also a debate raging over how many minutes the delay should be. Doug Stein, a local trader who helped organize the Eurodollar options pit protest, told Reuters that the five minute reporting delay was an “eternity.” But Melamed, acording to Reuters said, “It’s anyone’s guess whether five minutes is too much.”
Now that CME has decided not to change its policies around reporting block trades, it’s not clear what the floor brokers will do. “The exchange is not interested in changing anything,” Stein told Reuters.
As far as making a point goes, the floor brokers showed their absence depressed volumes when they left their posts. Why shouldn’t the traders walkout? After all, teachers, firefighters and transit workers go on strike and shut down service and that’s how they get attention from politicians to negotiate their contracts. While we are used to unions staging walkouts, the capitalists appear to be taking a page from Occupy Wall Street.
But in financial markets human walkouts are not as effective, since computerized trading can shift the information in nanoseconds to upstairs parties.
Perhaps the CME locals fear that dark blocks will lead to dark pools, private networks that exist in US equities, will soon invade and siphon liquidity from the Eurodollar pits? Once block trades are negotiated off the floor, aren’t they are one step closer to being traded on the screen?