Trading experts say change will increase transparency, liquidity


Capital Press

The Chicago Mercantile Exchange will begin pit trading on options for cheese, dry whey, nonfat dry milk and cash-settled butter Dec. 20 as an addition to its current electronic options trading.

The addition "is a result of conversations with some customers on terms of what works," said Chris Grams, CME Group associate director of corporate communications.

While it's unique to move from online trading to the pit, options are easier to trade in the pit because of their complexity, said Alan Levitt, publisher of CME's Daily Dairy Report.

"They don't lend themselves to trading electronically," he said. "For instance, most of the volume of Class III (milk) options is from the pit, even though most of the volume of Class III futures are electronic."

CME has been moving toward electronic trading of all contracts and has not offered pit trading on cheese, butter, whey and nonfat dry milk, but the industry requested pit trading on options as a means of boosting liquidity, he said.

Traders, including farmers, can sell a futures contract to hedge their risk if prices fall. The contract is an agreement between buyer and seller for an amount of product with a set price to be delivered on a specified date. The contract can be traded to another market participant before delivery, and most are.

Buyers take delivery of the product and sellers make delivery of the product. But if a buyer or seller doesn't know if he'll want the futures contract at delivery time, he can use option contracts instead.

The option guarantees the right to buy or sell the contract at a fixed price but doesn't obligate either party until certain criteria are met. Participants utilize futures and options to establish price floors and ceilings to protect the risk against volatility.

There are two types of options. Put options are the right to sell a futures contract at a certain price. They act as insurance against a down market and are useful to sellers of commodities, like dairymen. Call options are the right to buy a futures contract at a certain price and enable buyers to purchase protection against rising dairy prices.

Electronic trading works well for futures contracts, and the majority are traded online, said Peter Turk, of Rice Dairy.

"Futures are simple. You look at the contract and you buy it or sell it," he said.

But options involve calls, puts, different strike prices or a combination of those on one order. It's more complex, he said.

"In essence, because of the mechanics of options, especially if you need multiple months or combinations, it's harder to get the markets on the screen because your audience is limited. I can ask for multiple markets on the trading floor that has 10 to 20 market makers in the pit and receive those markets instantly, which provides our clients with immediate turnaround." he said.

"In a nutshell, it's going to expose the market to the public even more, with even more transparency than today. It's a good thing," he said.

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