between OTCs and exchange traded products. The advantage of
flex options is that participants can choose various parts of the
contract specification such as the expiry date and exercise price.
Table 4.2 The top exchange traded contracts
3
Rank Contract Exchange Country
1 UST-Bond CBOT USA
2 3-month Eurodollar CME USA
3 BUND Eurex Germany
4 3-Month Euromark LIFFE UK
5 US T-Bond options CBOT USA
6 Interest rate BM&F Brazil
7 3-month Sterling LIFFE UK
8 S&P 100 Index option CBOE USA
9 3-month Eurodollar option CME USA
10 BOBL Eurex Germany
Understanding the market structures
This section looks primarily at how the structure of the markets
for trading exchange traded derivative (ETD) products. An
exchange is the place where futures and options are traded by
members (corporates or individuals) who carry out their business
under the rules and regulations of the exchange. The exchange in
turn is subject to regulation by the domestic government
agencies.
The debate about which trading method, open outcry or elec-
tronic trading, has been raging for the last few years and the argu-
ment now appears to be tilting towards electronic trading. Since
the largest exchanges in the world, i.e. CBOT and CME are open
outcry, most of the trading is still done on the floor of the
exchange using this method. Electronic trading systems are
Managing Operational Risk in Financial Markets
Understanding the market structures
42
becoming more established with virtually all the new exchanges
adopting this method of trading. Even the open outcry exchanges
are using electronic trading systems to supplement the more tra-
ditional trading method. LIFFE has recently decided to list all its
products on an electronic platform and now offers both electronic
trading as well as floor trading facilities.
In light of the organizational and technological changes that have
taken place over the past few years, and the global nature of the
financial markets, it is surprising to note that the majority of the
futures and options business still takes place on the floor of
exchanges. In the futures exchanges, where the total dollar volume
of all futures contracts world-wide is over $500 billion
4
a day,
traders still meet in designated locations (the trading pit) and buy
and sell products by a combination of shouting and hand signals.
The process is known as open outcry, or pit trading or floor
trading. Figure 4.3 shows the trading volumes for open outcry and
electronic exchanges.
5
Whatever the trading mechanism, the exchange plays a key role in
4 Introduction to derivatives
Understanding the market structures
43
Figure 4.3 Trading volumes for open outcry and electronic
exchanges.
the trading process. The exchange, through its clearing house, acts
as the counterparty to every transaction and provides the systems
for the clearing and settlement of the contracts.
Impact of technology
Whatever the trading mechanism offered by the exchanges, tech-
nology has an ever-increasing role in this environment. For
example, the client enters the trade on a computer in their office;
this is automatically routed to the broker’s booth on the exchange
floor; the trader in the pit is informed through his headset; he exe-
cutes the trade on the floor and enters the details on his electronic
pad; the information is routed to the clearing house, price vendors
and the trade confirmed back to the client.
There is an increasing amount of technology on the trading floors.
CBOT’s
6
trading facility includes 12,000 computers, 6,000 voice
devices and 2,000 video devices all linked together with 27,000
miles of cable.
Despite all this technology, open outcry exchanges are under
increasing pressure to move to electronic trading. In Europe, the
battle for market share is at its fiercest between LIFFE, which has
traditionally operated open outcry, and Eurex, which is the largest
electronic exchange. The Eurex exchange was created by the
merger between Deutsche Terminborse (DTB) and the Swiss
Options and Financial Futures Exchange (SOFFEX). The battle in
Europe, at least, has been won by electronic trading with LIFFE
and MATIF both moving to electronic trading.
As the derivatives market becomes global, exchanges are linking
together in order to list their most successful products on mutu-
ally beneficial exchanges. There has been evidence of this recently
with LIFFE listing the Euroyen contract (also traded on TIFFE)
and the Japanese Government Bond (also traded on TSE). Both
contracts are cleared by the Japanese exchanges with open posi-
Managing Operational Risk in Financial Markets
Understanding the market structures
44

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